Critical Considerations When Saving For Your Child’s College Education — Part 1

September 30, 2022

Critical Considerations When Saving For Your Child’s College Education — Part 1

As you contemplate saving for your child or grandchild’s education, it’s worth it to consider whether you should use a 529 plan, an education savings account, or an Irrevocable Trust. Here’s what we think you should consider as you decide:

1st. Consider whether you want your children to have broader options than the traditional college experience.

Due to the recent outbreak of the pandemic, college enrollments have fallen by over one million students within two years. With college tuition getting more expensive every year, many students are considering alternatives to the traditional higher education path. Gap years, travel, trade programs, and online training are replacing the traditional college education path for many.

If you want that to be an option for your children or grandchildren, you should be aware that the traditional college savings plans may not be the right fit for your family. Instead, consider whether it may make more sense to create an educational trust for your family, in which all of your children and grandchildren can benefit.

toddler wearing a mortarboard and putting coins in a jar

2nd. Consider the financial aid consequences of how you are saving for college.

If you think your child or grandchild may need or want to qualify for financial aid beyond student loans, the way you save for their education may significantly impact their ability to qualify. If your offspring need financial assistance to pay for their education, the way in which you choose to save mustn’t negatively impact their qualification for such assistance

3rd. Consider the income tax consequences of how you are saving for college.

When you set aside money, unless you are saving for retirement in a qualified retirement plan, the income earned on that money is subject to income taxes. However, with various types of college savings plans, you can defer or avoid income taxes altogether.

529 Plans & Education Savings Accounts (ESAs)

In 1996, Congress created 529 plans that allow individuals to save money for college costs. These plans have been one of the most popular options for covering college costs. In 2017, Congress expanded these plans to cover K–12 education. It also changed the program to pay up to $10,000 in student loan debt in 2019.

529 plans allow you to save money for future use, and this tax-saving advantage is one reason they’re so popular. The money you contribute grows on a tax-deferred basis, and withdrawals are tax-free, provided they are used for qualified education expenses, such as tuition, room and board, and other education-related fees. And many states also provide a tax deduction or credit for 529 contributions.

Some people find the 529 plan’s relatively high contribution limits appealing. here is no limit on how much you can contribute each year, although if you contribute more than $16,000 (the amount of the gift tax exemption limit in 2022), you can trigger federal gift taxes and the requirement to file a gift tax return. With many 529 plans, you can set up an automatic transfer to add money directly from your bank account to your 529 accounts. Plus, many 529 plans allow automatic contributions as low as $25 per month.

It may be tempting to save for your child’s future education with a 529 plan, but make sure you know the tax rules first. Keep in mind that to avoid paying taxes, plus a 10% penalty, the money must be used for eligible expenses only. Eligible expenses include tuition and fees, room and board, books, as well as computers and other items if they are required for classwork.

If your child decides not to go to college, you will pay income taxes plus the 10% penalty in order to withdraw the funds and use them for something else. The other downside to saving for your child’s education in a 529 plan is that your investment options may be significantly limited to only a small selection of mutual funds.

Education Trusts

529 plans are quite popular, but there is another way to save for your child or grandchild’s education through the use of an irrevocable trust.

While there isn’t any income tax deferral on income earned by the assets held by these trusts, it is possible to structure a trust, so your beneficiaries could qualify for financial aid that they may otherwise be ineligible for with a 529 plan. If qualifying for financial aid would be even more valuable than savings on the income taxes owed on income earned by the trust, contact us to discuss setting up an educational trust for your family.

Next week, in part two, we’ll go into more detail about educational trusts. For now, take into consideration what matters most to you when it comes to saving for college: tax savings, financial aid considerations, or a variety of investment and education options. Then, contact us if you’d like to consider the educational trust option as part of your legal and financial decisions for the people you love.

This article is a service of Greg Gordillo, Family Business Lawyer™. We don’t just draft documents; we ensure you make informed and empowered decisions about life and death for yourself and the people you love. That’s why we offer a Family Wealth Planning Session™, during which you will get more financially organized than you’ve ever been before and make all the best choices for the people you love. You can begin by scheduling a Family Wealth Planning Session via our online scheduler and mention this article to find out how to get this $750 session at no charge.


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