Many families have College Savings Plans. Although saving for college is strongly encouraged, how you set up these accounts and when you withdraw funds from your college savings plan, may have an impact on your eligibility for need-based financial aid and federal educational tax credits.
NOTE: The information provided on this page is general in nature. Consult a professional financial advisor or tax expert when considering an investment in a college savings plan.
Q & A
Q. What are the college saving plan options?
There are two primary college savings plans that offer tax advantages. The first is a Section 529 College Savings Plan and the second is the Coverdell Education Savings Account.
Section 529 Plans are named after the section of the Internal Revenue Laws the govern their operations. They are education savings plans operated by a state or educational institution designed to help families set aside funds for future college costs. 529 Plans are established for a specific beneficiary (a potential college student) typically by parents and grandparents.
Funds deposited into the 529 plan by the owners in 2018 are considered gifts to the beneficiary and are limited to the annual gift tax exclusion of $15,000. A special provision of the law allows each owner to make a one-time contribution of up to $75,000 (5-year combined gift) to the plan. Therefore, when the plan is owned by two individuals (i.e. both grandparents), the total upfront contribution is $150,000.
Q. Which education expenses may we pay from our 529 plan?
Tuition & fees,
Books & supplies,
Equipment required for course enrollment and
Most room and board expenses. (Eligible housing costs are limited to the school published amounts for cost of attendance purposes, if the student lives off-campus).
Computers that are required by the school are also a qualified expense.
The Tax Cuts and Jobs Act allows 529 Plans to pay up to $10,000 in K-12 tuition per student per year for tax years 2018 – 2025.
Q. Which education expenses may not be paid from 529 accounts?
Personal expenses or
Q. How are 529 plans treated when calculating financial aid?
529 Plans owned by either the student or parent(s) are counted as a parent asset which increases the financial aid you are eligible to receive.
529 Plans owned by grandparents or others are not counted as a family asset and do not affect your financial aid.
BEWARE, payments from a 529 Plan not owned by the student or parent are counted as student income, which typically reduces your eligibility for need based financial aid in the following academic year.
It is very important to plan the timing and amount of any payments from 529 Plans established by other family members.
See the section on Support from Other Family Members for more detail. Also check with your tax and financial advisors.
Q. Are there any tax advantages to investing in formal 529 college savings plan?
The total amount of gifts contributed to a 529 plan, plus all of the earnings, are distributed “tax free” if used to pay qualified education expenses of the beneficiary.
Some states allow a state income tax benefit as well. Check with your tax advisor for details.
Contributing to a 529 plan may be a useful estate planning tool.
Q. Do payments from a 529 plan affect our federal education tax credits?
MAYBE. If you qualify for the American Opportunity Tax Credit or the Lifetime Learning Tax Credit, be aware that payments from 529 plans do not count as payments made by you. See below for more details.
Q. What effect does payments from my 529 college savings plan have on the American Opportunity Tax Credit?
If you qualify for the maximum American Opportunity Tax Credit, you should pay at least $4,000 of qualified education costs each tax year from your own funds (not from your college savings plan). You should monitor how your college expenses are paid in each tax year, not just in academic years. The maximum American Opportunity Tax Credit is $2500 per year/per student – for the first 4 years of college. So there is real money at stake. Make sure you speak to your tax or financial adviser before deciding when to use your college savings plan funds.
Q. What if we don’t have enough funds in our 529 college savings plans for all four years?
Most families are not fortunate enough to have a 529 college savings plan that will cover all four years of college expenses.
If parent borrowing is a component of your college payment planning – using funds from your 529 college savings plan first, and then borrowing in later years will reduce the amount of interest that you pay.
Q. What if we saved more in our 529 college savings plan than we eventually need?
This may happen when a student qualifies for a large scholarship or chooses to attend a low cost college.
If the student plans to attend graduate school, then the remaining 529 funds can be used to pay for qualifying expenses at graduate school OR transferred to a college savings account of another qualifying student.
The worst-case scenario is that you liquidate the 529 account and pay any tax and penalties.
Q. Should we consider a 529 College Savings Plan for our younger children?
It depends on your situation. Review the Important Considerations in the right hand margin of this page and consult with your financial advisor.
If you would like to research options on your own, SavingForCollege.Com provides very detailed information on 529 college savings plans.
Q. What is a Coverdell Education Savings Account?
A Coverdell ESA account is like an IRA. It is established for a specific beneficiary and has a $2,000 per year contribution limit. The contributions, plus the earnings, may be distributed “tax free” if used to pay qualified education expenses (see above). Unlike a 529 Plan, the Coverdell ESA may be used to pay for K-12 education costs and the owner may direct the investments.