Understanding your options for educational funding


Tuition costs have risen dramatically over the last 30 years, and parents need all the help they can get in financing a college education. There are a number of options available, including 529 plans and Coverdell accounts, so it’s important to consider carefully the appropriate way to help pay for higher education.

Article highlights

  • Think about a 529 plan for college expenses
  • Tax-free growth potential
  • Consider a Coverdell account

What is a 529 Plan?

A 529 plan is an education savings plan designed to help families set aside funds for future college costs. It is named after Section 529 of the Internal Revenue Code.

Tax Advantages of a 529 Plan

Any earnings generated grow federal income tax free (and may also be eligible for state tax deductions) as long as withdrawals are used for qualified higher education expenses.

Section 529 plans are established by various states and offered to residents of all states. Depending on the laws of the customer’s home state, favorable tax treatment may be limited to investments made in a Section 529 plan offered by the customer’s home state.

To be eligible for favorable tax treatment afforded to any earnings portion of the withdrawals from Section 529 plans, such withdrawals must be used for “qualified higher education expenses” as defined in the Internal Revenue Code. Any earnings withdrawn that are not used for such expenses are subject to federal income tax and may be subject to a 10% additional tax, as well as applicable state and local income taxes.

Professional Management

College savings plans offered by each state differ significantly in features and benefits. They are state-sponsored programs, usually managed by a financial services firm.

The ongoing investment of the account is handled by the Plan. Plan assets are professionally managed either by the state treasurer’s office or by an outside investment company hired as the program manager. 

Contribution Limits

There are no age or income restrictions for contributions or beneficiaries.

As much as $14,000 ($28,000 for married couples) can be contributed each year without gift-tax consequences as of 2016. 

A contribution of $14,000 a year or less qualifies for the annual federal gift tax exclusion. And under special rules unique to 529 plans, you can gift a lump sum of up to $70,000 ($140,000 for joint gifts) and avoid federal gift tax, provided you make an election to spread the gift evenly over five years.

Create a plan for each child

Every 529 plan requires a named custodian – typically a parent or grandparent – and a named beneficiary, the child. The account owner (i.e. the custodian) controls the account, including investment decisions and the distribution of assets. The account owner maintains ownership of the account until the money is withdrawn.

Each 529 plan account has one designated beneficiary. A designated beneficiary is usually the student or future student for whom the plan is intended to provide benefits. The beneficiary is generally not limited to attending schools in the state that sponsors their 529 plan.

There are no tax consequences if you change the designated beneficiary to another member of the family. Also, any funds distributed from a 529 plan are not taxable if rolled over to another plan for the benefit of the same beneficiary or for the benefit of a member of the beneficiary’s family. So, for example, you can roll funds from the 529 for one of your children into a sibling’s plan without penalty.

Consider the impact on financial aid

Whenever possible, it’s beneficial to have a 529 plan owned by a parent as it can impact a student’s financial aid eligibility. If a parent is named custodian of the plan, it will be assessed at a maximum rate of 5.64 percent when determining the family’s expected contribution (EFC*) vs. a rate of 20 percent if owned by the student.

Coverdell Educational Savings Accounts

Like a 529 plan, contributions made to Coverdell accounts grow tax deferred. The annual contribution limit per designated beneficiary in a Coverdell account is $2,000. Unlike a 529 plan, money saved in a Coverdell account can be used to pay expenses for both secondary and collegiate costs.

Custodial Accounts

Custodial accounts can be set up through both the Uniform Gift to Minors Act (UGMA) and Uniform Transfer to Minors (UTMA). They allow you to make a gift of cash or securities to minors. These accounts may offer tax advantages, investment options and provide you with flexibility—since the money can be used for more than just education. However, there are certain restrictions to carefully consider before establishing and using these accounts.

These options, in addition to using funds from existing investments or insurance contracts, can help you provide for students on their way toward higher education.

Education Tax Benefits which are a form of financial aid that students and their parents can take advantage of (if eligible) include: American Opportunity Tax Credit, Lifetime Learning Tax Credit, Student Loan Interest Deduction, and Employer Tuition Assistance. Tax breaks and incentives can vary state by state, as well as the limit on maximum allowable investment. You may want to consult with a financial advisor to determine which plan is best-suited for your child’s – and family’s – needs.

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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 Expected Family Contribution (EFC) is a measure of your family’s financial strength and is calculated according to a formula established by law. Your family’s taxed and untaxed income, assets, and benefits (such as unemployment or Social Security) are all considered in the formula. Also considered are your family size and the number of family members who will attend college during the year. The information you report on your Free Application for Federal Student Aid (FAFSA) or your FAFSA4caster is used to calculate your EFC. Schools use the EFC to determine your federal student aid eligibility and financial aid award. *Note: Your EFC is not the amount of money your family will have to pay for college nor is it the amount of federal student aid you will receive. It is a number used by your school to calculate the amount of federal student aid you are eligible to receive.