By Theresa Cagle Fry, Senior Vice President and Manager IRAs, Retirement & Education Planning
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One scary financial mistake I often see parents make is underestimating the cost of a college education. For many parents, paying for college can cause fear and panic, but it doesn’t have to. With a little bit of planning, and a strategy for saving, you can address your education goals with a sense of calm purpose. But since it is October and officially spooky season, if you want to get your blood pumping, I’ve included a few references to some horror films you may want to check out to get your “Scary Movie” season started.
Cost of Attending College and the Burden of Student Loan Debt
When you consider the average one-year undergraduate cost for the 2023-2024 academic year for tuition, fees, housing and food for attending a four-year public out-of-state college was $41,920, and $24,030 for an in-state four-year public school[i], you may want to “Scream”! Over the past two decades, the cost of tuition and fees rose anywhere from 3%-6%, depending on the type of school.
Collectively, students and their parents are borrowing a lot of money to pursue college degrees. Depending on whose numbers you look at, there is anywhere from $1.74–$1.75 trillion in student loan debt held by roughly 43 million Americans. Those are some frightfully large numbers! The average U.S. household with student debt owes $55,347, according to NerdWallet’s 2023 household debt study. But here’s some good news to put you out of your “Misery”. There are other options that are much less frightening than shouldering a large amount of debt, but to get the greatest benefit from them you need to start planning and saving early.
The Benefits of Saving and Investing with a 529 Education Savings Plan
One way to approach saving for future education costs is using a 529 education savings plan. 529 plans, which are named after the Internal Revenue Code section that created them, provide income tax benefits and make saving for education expenses “Child’s Play”. Contributions can be made in one of two ways. The first is by making annual gifts, which are limited to $18,000 this year. Alternatively, you can use a special advanced funding rule that allows up to five years of annual gifts to be made at one time. This increases the contribution amount to $90,000[ii]. For married couples, both spouses can make gifts to the same student/beneficiary, doubling the amounts to $36,000 using an annual gift and $180,000 using the five-year advance gifting election.
Although there is no federal income tax deduction available for contributions made to a 529 education savings plan, investments grow tax-deferred and, if used for qualified education expenses, the withdrawals will be income tax free[iii]. 529 savings plans are sponsored by states, and many will provide the contributor with a state income tax deduction or credit, which is typically contingent upon the contribution being made to the 529 plan that is sponsored by the state you reside in, although a few exceptions apply.
Anyone can save and invest using a 529 plan. Although a parent is typically the account owner—the individual who is responsible for investing and authorizing the withdrawals that are made— grandparents, other family members or friends can make contributions to the 529 education savings plan for the same student (also known as the beneficiary).
529 Plan Balances Can Be Used for Repayment of Student Loans or Funding a Roth IRA
If you have avoided starting a 529 plan or saving for your child or grandchild to attend college out of a fear they may not attend, or if you have concerns about them having leftover savings after college, fear no more! 529 education savings plans are more flexible than ever before.
For students who will attend a college or university, tax-free benefits from a 529 plan generally include tuition and fees, books and supplies, housing, and food. But 529 savings plans can also be used tax-free for K-12 tuition (up to $10,000 per year), for trade schools or apprenticeship programs after high school, and for repayment of student loan debt (up to $10,000) for the student or siblings of the student[iv].
An account owner also has the flexibility to change a beneficiary, income tax free, to another eligible family member. For example, you could move all or part of the savings from your oldest child to a younger child or keep the savings in the 529 plan and in the future change the beneficiary to the current beneficiary’s children.
Long-term, unused 529 education savings plan balances can also be moved tax-free to a Roth IRA. This new 529 savings plan to Roth IRA feature began in 2024 and can be a terrific way to jump start retirement savings for a recent college graduate. To be eligible to transfer 529 savings plan balances to a Roth IRA:
- Balances transferred must be from a 529 savings plan that has been established for at least 15 years and cannot represent any contributions or earnings from the prior five years.
- The Roth IRA must be for the 529 plan beneficiary (not account owner), and they must have earned income, although the typical Roth IRA modified adjusted gross income limits do not apply.
- Annually, the amount transferred to the Roth IRA cannot exceed the Roth IRA contribution limit (for 2024 this amount is $7,000).
- The total amount transferred during the 529 savings plan beneficiary’s lifetime cannot exceed $35,000.
If thinking about how you will pay for your children to attend college makes you a little “Psycho,” Benjamin Edwards can help. Your financial advisor can meet with you in “A Quiet Place” and work with you to develop a strategy that aligns with your savings goals. Don’t “Wait Until Dark”. Talk with your financial advisor today to get more information about the cost of attending college and how easy “It” is to begin saving and investing using a 529 plan.
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[i] The College Board, “Trends in College Pricing and Student Aid 2023”, Table CP-1.
[ii] When making the election for advanced 5-year gifting to fund a 529 education savings plan for the maximum amount, any additional gifts made to the student/beneficiary during the 5-year period would be considered a taxable gift, unless the gift tax exemption increases. With the advanced gifting election, the gift is prorated over five years equally.
[iii] Withdrawals that are not used for qualified education expenses typically result in federal income taxes and a 10% penalty on the earnings portion of the withdrawal. Some exceptions to the penalty apply. Non-qualified withdrawals can also result in a recapture of state income tax benefits previously received.
[iv] These uses of 529 savings plans, although recognized as qualified tax-free distributions for federal income tax purposes, may not be considered qualified distributions for your state income tax return. State non-qualified withdrawals can result in a recapture of the previously provided state tax deduction or credit.
IMPORTANT DISCLOSURES: The information provided is based on internal and external sources that are considered reliable; however, the accuracy of this information is not guaranteed. This piece is intended to provide accurate information regarding the subject matter discussed. It is made available with the understanding that Benjamin F. Edwards is not engaged in rendering legal, accounting or tax preparation services. Specific questions on taxes or legal matters as they relate to your individual situation should be directed to your tax or legal professional.