August brings with it thick humidity, the return of college football, and lunch boxes, new book bags and apple-smocked outfits as kids go back to school. While for many, this Staples commercial nails the joy of back to school, parents who have inadequately saved for college may not feel quite as enthusiastic.
Student loan debt has ballooned to $1.36 trillion, and according to Student Loan Hero, the average Class of 2016 graduate has $37,172 in student loan debt, a six percent increase from the previous year.
One way parents can help alleviate this debt burden is to start saving early! There are several good options for college savings. One of the most popular is a Section 529 plan. Section 529 plans are an effective means to help children, grandchildren, or other loved ones pay for college or graduate school.
Earnings are not subject to federal income tax and generally not subject to state income tax as long as they are used for qualified undergraduate and graduate education expenses, including tuition, fees, books, and room and board. It is important to note that 529 plans cannot be used for private primary and secondary schools.
Contributions to a 529 plan are subject to Federal gift tax rules, which means you can contribute up to $14,000 a year (as of 2016) without it being considered a taxable gift. Couples can jointly apply their gift, which means you and your spouse can contribute up to $28,000 a year without triggering a taxable gift. Additionally, you can make a lump sum contribution of up to $70,000, which the IRS considers the equivalent of five $14,000 gifts made over a five year period ($140,000 if made jointly). If you choose to go the lump sum route, any additional gifts made to the beneficiary of the 529 plan during the five year period will be considered taxable.
Many states ended the state income tax deduction offered for residents who contribute to their state 529 plan, which means the tax advantages of staying close to home have ended. We recommend shopping around for plans that offer diversified and low cost investment options such as index funds and passive ETFs.
Grandparents or other family members who are looking for opportunities to reduce the size of their estate can also use college as a means to do so. Direct payments to educational institutions, including primary, secondary, college and graduate school are exempt from federal gift taxes (as are direct payments for medical expenses). This means Grandmama and Granddaddy can write a check directly to Junior’s school to cover tuition, even if the school is Harvey Mudd College, Business Insider’s most expensive college in America for 2015, without it being considered a taxable gift. Direct gifts do not cover books, supplies, room and board; however, a grandparent could write a check for tuition and then provide Junior up to $14,000 to use for his other education expenses that year – all without triggering the gift tax.
In the event your parents have expressed an interest in paying your children’s tuition, thank them. Next, you may consider contributing a smaller amount to a 529 plan to have some funds available for non-tuition expenses.
If you decide on a 529 plan, there is a delicate balance in funding enough to avoid a heavy burden come freshman year while not overfunding these plans. In the event, however, that your 529 plan is larger than you need, there are several options:
- Change the beneficiary of a 529 plan to another family member. If your child gets an athletic or merit scholarship and doesn’t need the funds in his or her 529 plan, you can always save the funds for graduate school or change the beneficiary to another sibling.
- Reclaim assets not needed for educational expenses, subject to a 10% penalty on earnings (no penalty is applied on the original investment).
- Parents and grandparents can use 529 plan funds for individual courses at local universities or community colleges, as well as educational alumni trips.
Please contact us if you have any questions about 529 plans or other direct gifting options for college payments.