The 529 Plan is just the beginning
by Leo Chubinishvili, CFPMr. Chubinishvili is a financial advisor with Access Wealth in East Hanover, New Jersey. Visit www.access-wealth.com.
Congratulations on the birth of your child (or grandchild). Now, what can you do to help pay the staggering cost of college? With some private schools now costing in excess of $80,000 a year – just think what they will cost 18 years from now – planning needs to be done sooner rather than later.
Any client recommendations should begin by encouraging the opening of a 529 college savings plan at the time of the child’s birth. This way, they benefit from compound investment returns over time, in addition to the gains that are not taxable as long as the funds are used for educational purposes. Additionally, setting up automatic monthly contributions will steadily grow the education fund. Potentially, encouraging gifts from family and friends to the educational fund instead of traditional gifts can also help.
When it comes to 529 plans, clients should also consider the benefits of the following:
Transferring the 529 Plan to a Roth IRA
Starting in 2024, a new provision allows for the transfer of up to a lifetime limit of $35,000 from a 529 plan to a Roth IRA for the beneficiary. This transfer is tax- and penalty-free. However, note these specific conditions:
- The 529 plan must be held for at least 15 years for the designated beneficiary
- Annual conversions cannot exceed the annual Roth IRA contribution limit
- Funds contributed to the 529 plan in the last five years, including earnings on those contributions, are ineligible for the Roth IRA conversion
- The Roth IRA must be in the name of the beneficiary of the 529 plan.
Using 529 Plans for Legacy and Gifting
A 529 plan can be used as part of a legacy planning strategy. Contributions to a 529 plan are considered completed gifts for tax purposes, which can help reduce the size of an estate.
Beginning in 2024, taxpayers are able to make a lump-sum contribution to a 529 plan of up to five years’ worth of annual exclusion gifts without triggering the gift tax in the amount of $90,000 per individual contributor, or $180,000 for a married couple. This process can be repeated every five years.
Owners of 529 plans can change beneficiaries to other family members, allowing funds to be used for different generations. Upon the owner’s death, the plan transfers to a contingent owner or, as per state law, facilitating the tax-free passage of educational funds across generations.
An Education Savings Account (ESA) is another investment opportunity. Other options for funding a child’s education could be UGMA or UTMA accounts, or treasury bonds. However, in most cases, these offer no more benefits than those found in a 529 plan.
Clients can also benefit by integrating education planning into their estate and retirement planning by following several innovative approaches:
Various trusts serve as versatile tools to achieve multiple objectives. They not only help in potentially reducing the size of an estate for tax purposes, but also provide a structured way to protect assets from creditors and ensure controlled wealth transfer to future generations. These trusts encourage and support educational pursuits, allowing for an effective and efficient way to align educational funding goals with overall estate planning strategies. Even charitable contributions can be incorporated into education and estate planning with trusts.
By creating trusts specifically for education, clients can control how and when the funds are used, ensuring they are strictly targeted for educational purposes. This approach offers potential tax advantages, such as reducing estate taxes over time. Additionally, education trusts can protect assets from creditors and offer a structured way to pass wealth to future generations, encouraging educational pursuits.
Setting up legacy scholarships in estate plans offer another strategy. Such a fund, created as part of an estate plan, allows individuals to support their educational goals. These scholarships can be named in honor of the family, creating a legacy that supports education for future generations.
Estate freeze techniques for education funding is another opportunity to consider within one’s estate planning. Estate freeze techniques like Grantor Retained Annuity Trusts (GRATs) can be used by locking in the current value of assets one transfers into a trust. Any increase in value over time benefits the future recipient, like a child’s education fund, without incurring significant additional taxes. This approach is particularly effective for assets expected to grow in value, efficiently transferring wealth for education purposes.
Grandparents can contribute to Roth IRAs with the intent of using them for their grandchildren’s educational expenses. Withdrawals from Roth IRAs are tax- and penalty-free as long as the account is at least five years old and the account owner is over 59 ½ years old. However, if the funds are used for qualified education, the penalty is avoided even if the owner is not 59 ½, though the earnings in the Roth would be taxable. It is important to remember that since money can always be borrowed for education, but never for retirement, this strategy must be carefully evaluated before Roth dollars are used for education.
Linking retirement distributions to educational funding offers another strategy. Using Required Minimum Distributions (RMDs) from retirement accounts to fund education allows for an efficient use of resources. This approach ensures that retirement savings are utilized in a meaningful way that aligns with personal or family goals, as RMDs can also be used to contribute into various education savings vehicles such as 529 plans.
Innovative use of life insurance can also be part of the overall strategy. Certain life insurance policies, especially whole and universal life, accumulate cash value over time. This cash value can be borrowed against or withdrawn to fund educational expenses. The death benefit can also be structured to provide a fund for education in the event of the policyholder’s untimely death. This strategy not only provides for educational needs, but also ensures financial security for the family.
Family Wealth Management
Finally, there are education-focused Family Limited Partnerships (FLPs). In an FLP, family members pool their assets to invest together, and a portion of the returns can be designated for education funding. This strategy fosters family unity and financial education, while also providing a structured way to fund education. The FLP can also offer potential benefits, such as estate tax reductions and asset protection.
There are additional recommendations you can make for clients to do throughout their children’s life to support their educational opportunities.
Consider the following:
- Conduct regular reviews. This involves re-evaluating the investment portfolio and savings strategy at frequent intervals.
- Increase the savings. As one’s income grows, consider increasing contributions to the education fund.
- Explore state benefits. Investigate to see if the state’s 529 plan offers tax benefits or matching contributions and have clients take advantage of them if applicable.
- Search for scholarship opportunities. Recommend clients research and apply for scholarships and grants that can supplement education savings.
- Investigate prepaid tuition plans. Look to see if prepaid tuition plans are suitable for locking in current tuition rates for state colleges.
Finally, once the child is approaching college, suggest they do the following:
- Develop a withdrawal strategy. Have them put in place a strategy for withdrawing funds in a way that maximizes tax benefits and reduces the impact on obtaining financial aid.
- Apply for financial aid. Recommend applying for financial aid early to understand what additional funds may be needed.
- Enforce the importance of managing a budget. Suggest they teach children how to manage a budget to control expenses during college.
Remind clients that there is no downside in funding a 529 plan should the child choose not to go to college or receives a full scholarship. These plans can be used for vocational training or transferred to another family member.
Financing a college education is already prohibitive, and will likely grow more so in the future. Helping clients put together a sound plan, however, can make it far more attainable.