By Carl Trevison and Stephen Bearce
In today’s landscape, students and parents have a variety of educational choices to consider. And with education costs on the rise, families are also presented with a wide range of expense payment options — and potential challenges.
As an investor, it’s important to understand how you can effectively save for your child’s or grandchild’s future. Here are three basic steps to help you understand your education savings plan:
- Take the time to understand your overall financial priorities.
- Evaluate and understand your savings vehicles.
- Have open and honest conversations with family members about expectations.
Understand your priorities
First, get your bearings with your family and ask yourselves how many years of education your savings need to cover and what types of education you’re saving for. Outside of the traditional four- year college model, community colleges, vocational schools, or military options may fit your or your child’s goals and often operate on a shorter time span than four years.
Understand your options
Once you get a sense of your family’s education needs and how your plan prioritizes education savings, it’s time to evaluate your payment options. Fortunately, parents and grandparents have more choices today than ever before. Whether you use funds from an education savings account, credit, or cash, you’ll want to know the benefits and implications of each option as you decide how to execute your savings plan.
Savings accounts
A financial advisor can help you choose from among a variety of savings vehicles — including 529 plans, Coverdell Education Savings Accounts (ESAs), and custodial accounts — while helping you select a plan and investment alternatives that may fit your needs and risk tolerance.
Additionally, you as the investor should recognize how each option can be implemented and structured for use. Talk through scenarios with a financial advisor: What happens if I take money out of this account early? How can I use an account if my child’s needs or education goals change? Knowing the impact of these scenarios will likely be important in your decision-making process.
Credit or cash options
Besides the funds from an education savings account, you may consider the following options for payment. By exploring all options, students and families may help minimize the amount of debt they accumulate while pursuing their educational goals.
- Utilizing loans to help cover expenses. Whether you are considering federal or private loans, evaluate your financial situation to determine how much you may need to borrow, which type of loan is best for your needs, and what your ideal repayment plan looks like.
- Using personal savings to cover a portion of the expenses.
- Scholarships and grants are available to those who meet certain criteria, such as academic achievements or financial need.
- Receiving gifts, such as cash from family members or loved ones, is another viable option.
Education savings account vehicles
With so many choices to save for education, be sure to work with a financial advisor to evaluate which one(s) may be right for your situation. This information only briefly describes some of your education savings vehicles, and these rules can be complex. Be sure to include your tax and/or legal advisors in your discussions, as well. For more details, see IRS publication 970.
529 savings plans are a flexible, tax‑advantaged option for families looking to save for current or future education expenses. The 529 plan can be an appropriate choice for those looking to save a small amount on an annual/monthly basis, as well as for high-net-worth individuals aspiring to make larger gifts to prefund an education and potentially reduce their estate. The benefits of these plans include:
- Funds potentially grow on a tax-deferred basis.
- Distributions may be federally tax-free, if used for qualified education expenses. Keep in mind, nonqualified withdrawals are subject to federal and state income tax and a 10% additional tax.
- In some situations, there may be state income tax benefits.
- Qualified education expenses include K-12 tuition up to $20,000 per year.
- Accelerated funding allowing 5-year annual exclusion gifts to “front load” plan.
- You have flexible options if you save too much or you want to change the beneficiary to another eligible beneficiary.
- You may pay off up to $10,000 of qualified student loans.
- 529 designated beneficiaries can make a rollover contribution from their 529 to their Roth IRA if certain conditions are met:
- 529 account must have been opened for at least 15 years
- Contributions and earnings on those contributions made within the last 5 years are ineligible for rollover
- Maximum rollover lifetime limit of $35,000
- Subject to annual Roth IRA contribution limits
- Roth IRA owner must have earned income at least equal to the amount to the rollover
Some of these rules are complex, and the availability of such tax or other benefits may be conditioned on meeting certain requirements. Contact your tax advisor for details.
Coverdell Education Savings Accounts (ESAs) may be an appropriate option if you are looking to save for education but may not have as much to gift. Contributions to ESAs are limited to an annual maximum of $2,000 per beneficiary. Eligibility for contributing to these accounts begins being phased out with MAGI of $95,000/single taxpayer or $190,000/joint taxpayer.
- These accounts are self-directed and offer the benefits of annual tax deferral on account earnings.
- They also offer the potential for federally tax-free distributions for elementary, secondary, and post-secondary education.
- Excess funds in this account may be rolled over by an account holder prior to turning 30 to another eligible family member under the age of 30 (unless they are a special needs beneficiary) or contributed to a 529 for the beneficiary or eligible family member to avoid a non-qualified distribution.
Custodial accounts may be another way to save for a child if you are interested in saving, not only for education expenses, but other items as well.
- Funds may be used for other purposes, if they are for the benefit of the child, based on state law.
- Contributions you make to this account would be subject to gifting rules, and account earnings could be subject to kiddie tax rules annually.
- Since gifts to these accounts are irrevocable and the child generally gains full control of the funds upon reaching the age of majority in their state, you may want to be thoughtful about how much to save in these accounts.
Schedule an education planning conversation
Schedule an education planning conversation and share your savings goals with your family today. Talking about money openly can help create a shared understanding of your family’s finances and help build a foundation for your children to think critically about their money as they pursue their education.
Share your goals and evaluate your education savings plan with a financial advisor. They can help connect you with financial resources to aid in the planning process and advise how to pivot when life changes happen.
*Please consider the investment objectives, risks, charges and expenses carefully before investing in a 529 savings plan. The official statement, which contains this and other information, can be obtained by calling your financial advisor. Read it carefully before you invest. The availability of such tax or other benefits may be conditioned on meeting certain requirements.
Wells Fargo & Company and its affiliates do not provide legal or tax advice. This communication cannot be relied upon to avoid tax penalties. Please consult your tax and legal advisors to determine how this information may apply to your own situation. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your tax return is filed.
This article was written by/for Wells Fargo Advisors and provided courtesy of Carl M. Trevisan, Managing Director-Investments and Stephen M. Bearce, First Vice President- Investments in Alexandria, VA at 800-247-8602.
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