The cost of a college education is typically the first great expense a young person encounters. According to the Massachusetts Educational Financing Authority (www.mefa.org), an average in-state public college will run roughly $24,000 for the 2023-2024 year and a little more than $100,000 for a four-year degree. Meanwhile, the average private college will cost about $55,000 for a starting freshman and could total more than $230,000 over the course of four years. Herbert Stein, an American economist, famously said, “If something cannot go on forever it will stop.” The growth of college costs will peak at some point and then recede; when that will occur is much more difficult to predict. Until that time, we will address circumstances as they currently are—how to finance this significant expenditure and how to view saving for college as a wealth transfer strategy.
For the purposes of this piece, we will assume that our future student, Susan, is fortunate enough to have wealthy grandparents interested in financing her education. Everything that follows holds true if it were Susan’s parents providing the funds instead of Susan’s grandparents.
There are essentially three methods to fund Susan’s education: pay-as-you-go, establish an education trust, or use an education savings plan. Pay-as-you-go means just that—pay the tuition bills as they arise from cash on hand. An education trust would allow the grandparents to reduce their taxable estate by donating funds to such a trust, but the trust would remain a taxable entity and contributed funds would no longer be assets of the grandparents. An education savings plan usually means investing in a 529 plan—a tax-advantaged vehicle that allows after-tax contributions to grow and be withdrawn tax-free as long as they are used for qualified educational expenses. Because 529 plan assets grow free of tax, these plans are frequently started when the future student is very young, maximizing the time contributed assets have to grow. There are also private college 529 plans—essentially pre-paid tuition plans—but those are a topic for another day.
For Susan’s grandparents, electing to pay-as-she-goes offers a simple method for funding her education. The grandparents are protected in that the funds remain in their name until they are disbursed, so if Susan never goes to college, the assets belong to the grandparents and not Susan. Lastly, payments to educational institutions do not count against annual gifting.
529 plans offer other advantages. One major advantage is tax-free growth. If Susan’s 529 were started when she was born, her account would benefit from (typically) 18 years of tax-free growth. Assuming an annualized return of 5%, $10,000 invested in a 529 becomes $24,000 after 18 years. The contribution limits for 529 plans are currently $17,000 per person per year with the option to front-load a plan with 5-years’ worth of contributions, or $85,000 per person. This means two of Susan’s grandparents could, jointly, set aside a maximum of $170,000 (using 5 years of annual gifting) to kick-start her fund. That $170,000, compounding at our hypothetical 5% would become approximately $409,000 by the time Susan was ready to enter college—enough to cover current private college expenses with funds left over.
529 plans also benefit from an owner/beneficiary structure. In our example, Susan’s grandparents own the plan with Susan named as a beneficiary. Similar to pay-as-you-go, if Susan foregoes college, the assets remain her grandparents’. The funds can be redirected by naming another of Susan’s family members as the new beneficiary, or the funds can be withdrawn—subject to a 10% penalty on the contributed amount plus income tax on the earnings.
The tax-advantaged nature of a 529 plan, its ability to be funded with accelerated gifting, and the transferability to different beneficiaries all render these plans an interesting tool for estate planning as well as college savings. Wealthy grandparents like Susan’s who decide to contribute $170,000 to a new grandchild’s 529 plan can accomplish several simultaneous goals. First, depending on the actual investment returns, they have more than likely fully funded that child’s college education (and potentially graduate school). Second, they have relieved their children (in our example Susan’s parents) of the necessity to save for college, allowing them to address other financial priorities. Third, the grandparents have reduced their own taxable estate, not just by the amount of their initial contribution, but by any future appreciation that occurs in the plan both tax-free and outside of their estate.
The SECURE Act of 2019 added a new feature to address any excess 529 plan assets. Subject to certain conditions, 529 plan assets can be rolled over into a Roth IRA for the beneficiary, up to a lifetime limit of $35,000. Excess assets could also be left in the plan to fund the future education expenses of Susan’s family members including those of a generation above or below her—her parents or her own children, nieces, or nephews. Moving beyond one generation, for example trying to use plan assets to provide for Susan’s grandchildren, may subject the assets to penalties and income taxes; however, there are gifting strategies that can be employed to mitigate or even avoid such taxes and penalties altogether.
As with most wealth-transfer strategies, 529 plans should be considered in conjunction with other strategies and coordinated (if appropriate) among all parties involved, including parents and grandparents. Manchester Capital has advised clients on using 529 plans as an element of broader wealth transfer strategies. If you are interested, or would like to learn more, please contact your wealth manager.
 A family member of the beneficiary is defined by the IRS to be the father, mother, or ancestor of either parent, a child or the descendant of a child, a stepfather, stepmother, stepson, stepdaughter, brother sister, stepbrother, stepsister, half-brother, half-sister, aunt, uncle brother-in-law, sister-in-law, son-in-law, daughter-in-law, father-in-law, mother-in-law, niece or nephew, the beneficiary’s spouse, or a first-cousin.
This material is solely for informational purposes and shall not constitute a recommendation or offer to sell or a solicitation to buy securities. The opinions expressed herein represent the current, good faith views of the author at the time of publication and are provided for limited purposes, are not definitive investment advice, and should not be relied on as such. The information presented herein has been developed internally and/or obtained from sources believed to be reliable; however, neither the author nor Manchester Capital Management guarantee the accuracy, adequacy or completeness of such information. Predictions, opinions, and other information contained in this article are subject to change continually and without notice of any kind and may no longer be true after any date indicated. Any forward-looking predictions or statements speak only as of the date they are made, and the author and Manchester Capital assume no duty to and do not undertake to update forward-looking predictions or statements. Forward-looking predictions or statements are subject to numerous assumptions, risks and uncertainties, which change over time. Actual results could differ materially from those anticipated in forward- looking predictions or statements. As with any investment, there is the risk of loss.
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