SAVING FOR

BY EVERETT A. CHASEN

In 2021, my wife and I became grandparents. Like all grandparents, we have many hopes and dreams for our grandson. While he will shape that future on his own, there’s one wish we can do something about ourselves: We want him to be able to attend the best college that accepts him without being crushed by a lifetime of debt.

To help accomplish this goal, we opened a Section 529 savings plan account with our grandson as the beneficiary. The US Securities and Exchange Commission (SEC) defines a 529 plan as “a tax-advantaged savings plan designed to encourage saving for future education costs.” Such plans are sponsored by states, state agencies or educational institutions, and are authorized by Section 529 of the Internal Revenue Code.

here are two types of 529 plans: prepaid tuition and education savings. All 50 states and the District of Columbia sponsor at least one of these, and a number of private colleges and universities also sponsor prepaid tuition plans.

In prepaid tuition plans, parents, grandparents, and other interested parties can “lock in” today’s tuition rates, and the program will pay out future college tuition at any eligible state-run college or university. If the student chooses to attend a non-state university, the program will pay out an equal amount to that school.

Education savings plans allow participants to save money in a special college savings account on behalf of their designated beneficiary’s qualified higher education expenses.

Both programs are considered “qualified state tuition programs” by the Internal Revenue Service (IRS). Earnings from investments that are used to pay for qualified higher education expenses are federally tax exempt. Most states also exempt earnings from state income tax, and some states allow families to deduct the full or a partial amount of their contribution from their state income tax. Earnings on most other savings or investment accounts, like mutual funds, are commonly subject to capital gains taxes when they are withdrawn.

In addition, 529 plan contributions are considered by the IRS to be a gift to students. In 2023, contributions of up to $17,000 a year from individuals, or $34,000 a year from married couples, are tax-free gifts.

The IRS defines eligible institutions as “any college, university, vocational school, or other post-secondary educational institution eligible to participate in a student aid program administered by the US Department of Education (ED).” Certain foreign institutions are also included. Tuition payments can also be made to elementary or secondary public, private or religious schools.

ED offers a Federal School Code Search program at https://studentaid.gov to help applicants determine if a desired school is eligible. The search tool also provides detailed information by school, including tuition and fee amounts and graduation rates, and allows users to compare that information for up to 10 colleges at a time. The Department notes that each qualified state tuition program operates under the laws of the individual state, so 529 programs may vary from state to state.

Although our grandson and his parents live in another state, we chose to open an account for him in our home state of Virginia. It allows us to deduct contributions of up to $4,000 per account per year with an unlimited carry forward to future tax years, subject to certain restrictions. Once we reach age 70, we can deduct the entire amount we contribute.

We decided on an education savings plan, not a prepaid tuition plan, because although the state in which our grandson lives has an excellent state university system (as does Virginia), we hope our contributions will allow him to attend the best school he qualifies for and wants to attend, anywhere in the world.

Advice From a Financial Planner

The US Securities and Exchange Commission (SEC) defines a 529 plan as “a tax-advantaged savings plan designed to encourage saving for future education costs.” Such plans are sponsored by states, state agencies or educational institutions, and are authorized by Section 529 of the Internal Revenue Code.

“We’ve set up a number of 529 plans for my retired clients and their grandkids,” Mark A. Keen, a Certified Financial Planner who writes NARFE magazine’s “Managing Money” column, tells us. “Most of my [older] clients are well off and can afford retirement without any issues. Regardless of what goes on in life, they’re not going to spend down all their assets. So, they’re going to die with money in the bank. They won’t get any fulfillment from seeing [their heirs] enjoy that.”

“So, I encourage my clients to gift to their kids and grandkids, including to help pay for expenses that may otherwise be out of reach for them,” he continues. “College is a big one [in that category.] In many cases, 529 plans offer a great solution.”

Keen prefers education savings plans to prepaid tuition plans. “I usually don’t recommend [prepaid plans.] I just find they’re too limiting. You obviously get the biggest bang for your buck when you buy a Virginia plan and your child goes to a Virginia state school, but what if your child doesn’t want to go to a school in Virginia?”

“Also, some schools don’t participate in the prepaid program,” he adds. “I’d rather someone have a 529 savings plan, which has a lot more flexibility, and the student can go anywhere in the country, or even internationally.”

For parents, however, Keen has different advice.

“First and foremost, my recommendation to parents is to make sure you’re focusing on your retirement. Prioritize retirement before you start allocating your cash flow to college savings, whether it’s a 529 plan or some other type of college account,” he said. “There’s only a finite amount of time to save, and there’s only one way to pay for retirement—with your own money. Some people [like federal employees] have pensions or Social Security to supplement their savings, but that’s typically not enough.

“There are multiple ways to cover the cost of college, whether it involves using assets, current income, loans, grants, scholarships or work-study programs,” Keen said. “I always recommend clients focus on prioritizing their retirement first.”

Keen also advises parents to have conversations with their children as they get close to college age to set parameters about what they will and will not pay for. He suggests parents with limited means tell their kids: “We’re going to pay for an in-state school. And if you want to go to an Ivy League or another private school that’s going to cost two or three times what the state school is going to cost, that’s going to be on you. I just don’t agree with parents who feel they owe it to their kids to pay for their college educations regardless of the cost.”

Roth IRAs vs. 529 Accounts

There are ways to save for college other than 529 plans, of course. One vehicle Keen likes is the Roth Individual Retirement Account, or Roth IRA. IRAs are retirement savings accounts that offer tax advantages. Contributions to traditional IRAs may be fully or partially tax-deductible, depending on filing status and income. In general, funds in a traditional IRA, including earnings on investments, are not taxed until they are withdrawn.

Roth IRAs differ from traditional IRAs in that Roth IRA contributions cannot be deducted on your taxes. However, if you satisfy IRS requirements, qualified withdrawals are tax free. Accounts must be designated as Roth IRAs when they are set up.

“If income limits allow [my clients] to contribute directly to a Roth IRA, I encourage them to do that,” Keen explains. “I like the flexibility they offer, because you always have the ability to pull out your contributions taxand penalty-free, so you can use the money for other options than retirement.” Roth IRAs allow investments in stocks, bonds, mutual funds or exchange-traded funds (ETFs), whereas most states invest 529 contributions solely in mutual funds.

College Right Around the Corner? Try These Strategies

If your child has reached the age where college is just a few years away, and your college savings are small or nonexistent, there are still a few things you can do besides filling out the FAFSA and hoping for the best. These include:

• Encouraging your child to look for private scholarships as soon as possible, and to start planning to apply to any programs for which they may qualify.

• Suggesting your child take as many advanced placement (AP) courses or dual enrollment classes as possible, so the student can accumulate as many credits as possible at a cheaper price. Dual enrollment classes are taught at local colleges and are open to high school students.

• Starting to save now: you’ll be surprised how much you can save in just a few years.

• Curbing your family’s spending.

• Not being afraid to ask others for help. Everyone knows what college costs nowadays, and friends or family members may be in a position to assist.

Unlike 529 plans, third parties cannot contribute to Roth IRAs, but parents and grandparents can give students gifts, which the students can then contribute to their own account. All family members and friends can contribute to 529 plans, regardless of who owns the account.

In addition, Roth IRA retirement accounts are not considered assets on the Free Application for Financial Aid (FAFSA) form, the form needed to apply for federal student aid, including federal grants, work-study funds and student loans. Many states and colleges use the information on FAFSA to determine eligibility for state and school aid, and some private financial aid providers also use FAFSA information to determine whether students qualify for scholarships. Taxable earnings from Roth IRAs, however, are considered income on FAFSA, while non-taxable earnings are not considered income.

By contrast, the value of 529 plans—whether they are owned by a student or a parent—is considered a parental asset on the FAFSA, but withdrawals from parent- or student-owned accounts are excluded from federal income tax returns and do not have to be added back as income on the following year’s FAFSA.

There are income limits to establish Roth IRAs—in 2023, those are $138,000 or less for single filers wanting to make a maximum contribution, and $218,000 or less for married couples filing jointly—whereas there are none for 529 accounts. There are also contribution limits of $6,500 per year for IRAs for those under 50 years of age and $7,500 for those age 50 or older, compared to no limits for 529 plans. Certified Financial Planners like Keen can help you make the right choice for your family.

Other Options

Other options to help your child or grandchild save for college include Coverdell Education Savings Accounts (ESAs). Coverdell ESAs are taxadvantaged trust or custodial accounts specifically used to save for educational expenses. Earnings from the account are not subject to income or capital gains taxes as long as they are used for qualified educational expenses, and the savings can also be used toward educational expenses for elementary and high school.

“I very rarely see those,” Keen said.“You can’t put a lot of money in them. The contributions are limited to $2,000 per year—and they’re subject to lower income limits than Roth IRA accounts.” The income limit for the maximum contribution is $190,000 for joint filers. Parents with incomes above $220,000 are ineligible.

Federal employees and others may consider investing in U.S. Savings Bonds. They can do so through TreasuryDirect (www.treasurydirect.gov), a web-based system to purchase, manage, and redeem electronic savings bonds. TreasuryDirect allows government employees to participate through direct deposit deductions, which can be set up on the TreasuryDirect website and the Office of Personnel Management’s (OPM) Employee Express payroll system (www.employeeexpress.com.)

Savings bonds are federally tax-deferred and state tax-free, and series EE and I bonds purchased after 1989 are federally tax-free for qualifying higher education expenses for married couples with incomes under $128,650, or $100,800 for individuals. They are also a low-risk investment, but the return on that investment is generally not high.

The current values of the bonds, not their face value, are considered assets by FAFSA. If the bonds are in the parents’ name, they are counted as parental assets, and if they are in the child’s name, they are assets of the child. Parental assets have a lower impact on students’ potential aid.

Other investments include mutual funds, diversified investments managed by financial advisers, or bank investment specialists. You can spend the funds you save on anything you’d like, including education expenses, and there’s no limit to what you can invest. Mutual funds are subject to annual income taxes, and any capital gains, dividends, or bond coupon payments are taxed when shares are sold.

Custodial accounts are another option. These are brokerage accounts opened by adults on a child’s behalf, usually transferred to them once they turn 18, 21, or 25. Funds held in these accounts can be used on anything for the benefit of the minor; there is no limit to the amount that can be invested, and the value of the account is removed from the donor’s estate.

These accounts are taxed to the child, however, which can have tax disadvantages if the income on the account exceeds $2,300 in a year. Also, the accounts are considered student assets on the FAFSA, and can significantly reduce the amount of aid for which a student qualifies.

Regardless of how you choose to save for your child’s education, Keen has a final piece of financial advice: Pick a college that makes economic sense for you and your child.

Get Expert Advice as You Save for College

Keen & Pocock is a resource for NARFE members as they work to ensure their relatives’ financial future.

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Visit www.narfe.org/keen-pocock to get started.

Advisory services offered through Strategic Blueprint LLC. Securities offered through The Strategic Financial Alliance Inc. (SFA), member FINRA/SIPC. Strategic Blueprint and SFA are affiliated through common ownership but otherwise unaffiliated with Keen & Pocock.

“I went to a two-year college to cut costs, and then to an in-state college,” Keen recalls. “I had a little bit of debt coming out of school, but not much. Certain colleges make sense for certain students. There’s got to be a balance between college costs and college benefits. Today, it’s like we don’t want to look at these alternatives. But there’s a choice to be made. We have a choice.”

—EVERETT A. (EV) CHASEN IS A WRITER AND COMMUNICATIONS CONSULTANT IN THE WASHINGTON, DC, AREA. HE RETIRED FROM THE FEDERAL GOVERNMENT AFTER 35 YEARS OF SERVICE.