College Funding

Posted on Tuesday, May 7th, 2013

With advanced education as a prerequisite for most jobs and rising education costs that outpace broader inflation, how can you plan for your family’s education?

529 Savings Plans

Contributions to 529 plans are made with after-tax dollars and are allowed to grow tax deferred with tax-free distributions for qualified education expenses. Qualified expenses include almost all collegiate education-related expenses. Contributions must be made in cash with lifetime limits set by individual state plans, usually $200,000+ per beneficiary.  Limits on the amount that can be contributed are not phased out based on income.  Donors may even “frontload” these plans by contributing up to 5 years’ worth of annual exclusion gifts in one year ($14,000 for 2013 x 5 years = $70,000).  A gift exceeding these amounts can also be made; however, the excess (over $70,000 per person) will be reported as a taxable gift. Additionally, many states offer tax deductions in varying amounts for residents contributing to their state’s plan.  Investment options vary among plans.

Recommendation:  West Virginia’s plan through DFA and Iowa’s plan through Vanguard are most consistent with our investment strategy.
West Virginia:

Frequently Asked Questions on 529 Plans:

How will funding a 529 plan affect the beneficiary’s ability to obtain financial aid?  Assets in the student’s name may negatively affect their eligibility for financial aid.  Because parental assets are given less weight in calculations for financial aid eligibility, it is recommended that 529 ownership remain with parents/grandparents for the benefit of the student.

What are the gift and estate tax benefits of 529 plans?  As long as the amount contributed for each beneficiary is no more than the annual exclusion amount (or 5x that amount if frontloading), the transfer will not be subject to gift or GST taxes (Generation Skipping Transfer Tax).  An additional benefit of 529 plans is the ability to remove assets from the owner’s taxable estate, while maintaining control of the asset, a feature somewhat unique to this vehicle.

What if the beneficiary does not need all of the funds in the 529 plan?   Earnings withdrawn for nonqualified expenses are subject to ordinary income tax at the owner’s tax rate, as well as a 10% penalty (contributions may be returned tax-free).  Alternatively, the account owner can change the beneficiary to another qualifying family member, without incurring any tax or penalty. In the case of a student receiving a scholarship, the 10% penalty may be waived but earnings would still be subject to income tax.

How should my student’s 529 plans be invested? Most states that administer 529 plans have age-based risk programs that automatically shift the investment allocation based on the appropriate risk/return level for the beneficiary’s age.  While we do not provide the investment options, we are able to manage and monitor them for our clients to ensure proper investment allocation and distributions.

Other Funding Options

Taxable Investment Accounts:  Payments for tuition made directly to an educational institution on behalf of a student do not count towards the student’s annual gift tax exclusion amount. For example, a grandparent could fully pay for their grandchildren’s tuition (but not other educational expenses) while still making annual exclusion gifts to the beneficiary.

Custodial Accounts: UGMA/UTMA accounts are a good way to pass assets down to children for education purposes, but use caution because once the child turns the age of majority, there is a change of control and the child owns the assets outright.

Home Equity:  Rates are typically variable and liquidity may be an issue in the current real estate market; however, interest (in some cases) may be tax deductible.

Loans: If liquid assets are insufficient, a student loan may be necessary.  In addition to some private loans, government loans may also be available. The government’s Stafford student loan ranges from $3,500 – $5,500 per year with payments deferred until graduation.  Payments for parental PLUS loans begin immediately.

Life Insurance:  Some life insurance policies (high cash surrender value and low death benefit), can cover education expenses in the event of premature death while also providing the option to use loans against cash surrender value as a tax-deferred source of education funds during the life of the insured.  Furthermore, life insurance assets are typically excluded from financial aid calculations.

Retirement Accounts:  If the qualified plan (excluding IRAs) has loan provisions, clients may be able to take a loan against their retirement account leveraging the benefit of tax-deferred assets.  As long as the loan and interest are repaid within 5 years, income taxation and penalties on the withdrawal may not apply. However, extreme care should be taken when considering retirement assets since other financing is available for education funding, but not for retirement!

EE Savings Bonds: Fixed income instrument that returns a fixed amount in interest every year for 30 years. Interest on these bonds is tax-free if used for qualified education expenses. EE’s must be issued in the name of the issuer age 24 or over (usually the parent/grandparent). This exemption phases out for joint filers between $109,250 and $139,250.

Tax Credits and Deductions

Education tax credits and deductions may be available depending on individual tax situations:

American Opportunity Credit:  Up to $2,500 per student is available for the first four years of undergraduate education with a phase out for joint tax filers between $160,000 and $180,000 of modified adjusted gross income (MAGI).

Lifetime Learning Credit:  20% of qualified expenses up to a $2,000 maximum credit for undergraduate or graduate expenses with a phase out for joint tax filers between $107,000 and $127,000 of MAGI.  Only the American Opportunity Credit or the Lifetime Learning Credit can be used in the same year.

Deductions:  Additionally, up to $2,500 of student loan interest may be deductible (phase out for joint filers between $125,000 and $155,000 of MAGI) as well as up to $4,000 for qualified higher education expenses (phase out between $130,000 and $160,000 of MAGI for joint filers). is an excellent resource for additional information on college funding options.

Windham Brannon Financial Group, LLC (WBFG) obtains historical and other information from a wide variety of publicly available sources. We have taken all reasonable care and precaution to ensure that the information is fair and accurate, or has been compiled from sources believed to be reliable. Nevertheless, we do not make any representations or warranty, express or implied, as to the accuracy, completeness, or fitness for any purpose or use of the information. The information may not in all cases be current and it is subject to continuous change. Accordingly, you should not rely on any of the information as authoritative or a substitute for the exercise of your own skill and judgment in making any investment or other decision. We shall not be liable for any direct, indirect, or consequential loss arising from any use of or reliance on the information from this presentation. WBFG and its affiliates do not have, nor claim to have, sources of inside or privileged information regarding expected future returns on any investment proposed. The recommendations developed by WBFG are based upon the professional judgment of WBFG and its individual advisory affiliates and neither WBFG nor its affiliates can guarantee the results of any of their recommendations. Clients at all times may elect unilaterally to follow or ignore completely, or in part, any information, recommendation, or advice given by WBFG and its affiliates. Past performance is not necessarily indicative of future results.

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