If there is one thing you can count on, it’s the rising cost of education.
The United States spends more on college than any other country, according to the Organization for Economic Cooperation and Development (OECD). With families averaging about $30,000 per student a year, assuming a 4-year graduation rate (a rare feat) those costs climb to nearly $120,000.
That is in today’s calculations. For those with toddlers or young grandchildren, Investopedia estimates that bill to run almost $245,000 for four years at an in-state public institution when they grow up.
This financial burden leaves many students scrambling for loans that could take them decades to pay off. Many grandparents have a goal to help support their grandchild’s education but don’t know where to start. If this fits into your financial goals, there are a few good options to consider.
Today, we are going to look at four avenues to help save for your grandchild’s education. Let’s get started.
1. The 529 plan
529 plans are perhaps the most well-known college-savings avenue out there. 529 plans are tax-advantaged investment vehicles designed to support education costs. You contribute after-tax dollars into the account, the earnings grow tax-free, and all distributions are tax-free for qualified education expenses. What does this include?
Upon its conception, the funds from these plans could only go toward college tuition, fees, books, and supplies as well as room and board. But recent changes, including the SECURE Act, have allowed families more flexibility to use the funds to support K-12 education, registered apprenticeships, as well as student loan relief (lifetime $10,000 limit).
529 plans can be an excellent investment vehicle as they can be established in your grandchild’s name, and you can make any contributions on their behalf. In 2020, you can contribute a maximum of $15,000, the annual exclusion limit for the year. There is also a way for you to contribute up to 5 years of funds/gifts at once ($75,000), but that requires elaborate tax and planning preparation, so be sure you work with your respected professionals before gifting a lump-sum.
529 plans are tax-advantaged and allow you to contribute as you are able. Take a look at what you can reasonably add to this fund. Maybe it is $50 or $100 per month, and given that the average 529 plan sees about a 6% return, that could add up over time.
There are many different avenues to enroll in a 529 plan. Consult your financial advisor to register in the right plan for your unique needs. Consider the investment objectives, risks, charges and expenses before investing in a 529 College Savings Plan. Investments in a 529 plan are neither insured nor guaranteed and there is the risk of investment loss.
2. Individual Retirement Accounts (IRAs)
IRAs are almost exclusively discussed in the retirement planning sphere, and while that space is still its strong suit, these vehicles can also be effective in college planning.
You fund Traditional IRAs with pre-tax dollars, and distributions are taxed as ordinary income. The opposite is true for Roth IRAs. You fund these accounts with after-tax dollars, but all qualified distributions are tax-free. This presents many tax planning benefits for retirees and also for education savings.
Under normal circumstances, if you were to withdraw funds from an IRA before 59 ½, the IRS would issue a 10% penalty on the money. That penalty is waived for qualified education expenses. Keep in mind that by using funds from a traditional IRA, you would still need to pay income tax on the distribution. This makes a Roth IRA a more lucrative option as you wouldn’t need to pay additional tax on the money, and are still able to forgo the penalty.
Contributing to an education fund with your retirement savings does present some important consequences to think though.
- Ensure your retirement savings are on track. You don’t want to sacrifice your momentum, savings goals, and future retirement lifestyle for education costs. Be sure you prioritize your retirement plans.
- You can only contribute to an IRA if you are earning income, so if you aren’t working that is money that you can’t replenish.
- IRA distributions are considered income on financial aid applications, which could hinder your grandchild’s eligibility for need-based aid.
3. Coverdell Education Savings Account (ESA)
A Coverdell ESA operates in a similar way to a 529 plan. It is a trust or custodial account that sees tax-deferred growth and distributions for qualified education expenses remain tax-free. Like a 529, if you use the money for an un-qualified cost, you will owe taxes on the money and face a 10% penalty. But Coverdell ESAs are quite distinct from their 529 cousins.
Most Coverdell ESAs have more investment options and lower fees than 529 plans. But they also have smaller contribution limits, $2,000 per beneficiary in 2020. This limit applies to students with multiple accounts. For the money to remain tax-free, the recipient must be under 18 years old. There are numerous penalties and taxes for contributions and leftover money after the beneficiary surpasses that age, so keep that in mind if you are going to use this account.
They also carry an income threshold for contributing. Should your modified adjusted gross income exceed $110,000 for single filers and $220,000 for married couples filing jointly, you would be unable to participate.
4. Cash and personal resources
Cash is a quick and straightforward way to gift money to your grandchildren. Remember, the annual exclusion limit is $15,000 or $30,000 for married couples, which is a great way to give tax-free. If you exceed this limit, the gift counts towards the lifetime exemption, which is $11.58 million for an individual in 2020.
If you don’t want to write your grandchildren a check, there are several other ways to support them on their journey. Let’s look at a few examples:
- Put together a care package full of their favorite study snacks, movies, games, and more. This is a fun way to engage with them and bring a smile.
- Take them out to dinner. There is almost nothing a broke college student loves more than a nice meal out of their pajamas.
- Stay in touch. Whether you are a card, letter, phone call, texting, or email person, staying in touch is a great way to show your support and love for your family.
Give with intention
College is a considerable spending endeavor and likely filled with a lot of stress. You don’t want to add to that stress by giving money that you don’t really have. Before you decide to contribute to your grandchild’s education, take a look at your financial goals, and ask yourself some questions.
- How does this gift fit into your goals?
- Do you have the resources to contribute financially? If so, what does that look like?
- What resources will best allow you to help while still maintaining your desired lifestyle?
Remember, there are many ways for you to reach your goal to help pay for education. In all likelihood, it will be a combination of the things above, as opposed to one vehicle. No matter what, keep your goals at the center and work with an advisor who can help you craft a plan that works long-term.
Our team at TFS loves helping people use their money in a way that is true to themselves, their goals, values, and priorities. Do you want to add education funding to your financial plan? Set up a time to talk with our team today.
TFS Advisors and FSC Securities Corporation nor its representatives offer tax advice. These matters should be discussed with your tax professional.