When saving for your child’s or grandchild’s college education, you might consider a 529 plan, an education savings account (ESA), or an irrevocable trust. Here’s what to think about when deciding.
Broader education options: Consider if you want to provide alternatives to traditional college for your child or grandchild. Since the pandemic, college enrollments have dropped by over a million students. With rising tuition costs, many are looking at gap years, travel, trade programs and online training.
Traditional college savings plans like 529s might not be the best fit if these alternatives are appealing. An educational trust, benefiting all your children and grandchildren, might be more suitable.
Financial aid implications: How you save for college can impact eligibility for financial aid. If your child or grandchild might need financial assistance beyond student loans, the way you save could affect their qualification for aid. It’s crucial to choose a savings method that doesn’t negatively impact their aid eligibility.
Income tax consequences: Money set aside for education, unless in a qualified retirement plan, earns income subject to taxes. However, specific college savings plans offer tax advantages, deferring or avoiding taxes altogether.
529 plans and ESAs: 529 plans, established under Section 529 of the Internal Revenue Code, offer tax-deferred growth and tax-free withdrawals for qualified education expenses, including K–12 and up to $10,000 in student loan debt. Contributions may receive state tax deductions or credits and can be automatically transferred from your bank. High contribution limits exist but exceeding the annual gift tax exemption ($16,000 in 2022) could trigger gift taxes. Funds must be used for eligible expenses to avoid taxes and a 10-percent penalty. If not, withdrawals are taxed and penalized, and investment options are usually limited to mutual funds.
An Education Savings Account (ESA), also known as a Coverdell ESA, is a tax-advantaged account for education expenses. Contributions up to $2,000 annually grow tax-free, and withdrawals for qualified expenses (K-12 and higher education) are also tax-free. ESAs offer broad investment options and flexibility, though they have income limits for contributors and funds must be used by the beneficiary’s 30th birthday (unless they have special needs). The remaining funds can be transferred to another eligible family member.
Educational trusts: Alternatively, irrevocable trusts offer another way to save for education. While these trusts don’t provide income tax deferral, they can be structured to help beneficiaries qualify for financial aid, which might be more valuable than the tax savings on trust income. If financial aid eligibility is a priority, setting up an educational trust might be the better option.
Next week, we’ll delve deeper into educational trusts. For now, consider what matters most: tax savings, financial aid considerations or a variety of investment and education options.
Send your questions to ccolan@colanlegal.com and use “Alpine Mountaineer estate planning question” as the subject. We’ll answer your questions in our upcoming issues.
This article is provided by your local estate planning attorney, Corina Colan. The Law Office of Corina I. Colan / (909) 265-3315 / www.colanlegal.com
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