Navigating the options for college savings is no small task. We’re often asked how families can prioritize their needs and plan for the future, so we’ve put together our top FAQs.
How should I prioritize my goals to save for retirement and plan for my family member’s college education?
As the saying goes, “You can’t finance your retirement.” We encourage individuals to focus on retirement planning and building financial independence first before attempting to fully fund college savings. When the time comes to pay college expenses, you and your family member will have many options for financing, such as 529 plan funds, grants, scholarships, student loans, paying out of current income, or a combined approach. Unfortunately, these tools aren’t available for retirement savings, so it’s important to ensure your own financial independence in conjunction with a college savings goal.
It’s important to ensure your own financial independence in conjunction with a college savings goal.
Which college savings vehicle is best for my family?
Among college funding vehicles, 529 plans can make sense in many, but not all, situations. Whether or not to establish one depends on your specific goals and objectives. Often, the 529 plan is the preferred route given the low cost, flexibility, and contribution limits. 529 plans allow for a much higher contribution than other vehicles and for favored financial aid treatment when the Free Application for Federal Student Aid (FAFSA) form is reviewed. Additionally, 529 plan assets grow tax- free while invested in the plan, and withdrawals for qualified educational expenses come out of the plan tax-free. The 529 account gives the owner control of the assets for life, which adds unique flexibility.
529 plans can make sense in many, but not all, situations.
Who should own the 529 plan?
One of the first decisions you’ll need to make when establishing a 529 plan is who owns the account. On the 2024–2025 FAFSA form, the calculation for determining aid eligibility will no longer count grandparent-owned 529s (or 529s owned by family members outside the immediate household) or payments made from them. In light of this recent update, absent other fiscal responsibility considerations, it can be more beneficial for a grandparent, aunt, uncle, or other nonimmediate relative to retain ownership of the 529 rather than a parent, since parent-owned 529 accounts will still be considered in calculations for aid eligibility.
What happens if I don’t use all the 529 plan funds?
529 plans provide several options if the funds aren’t exhausted by the current beneficiary. You have the option of changing beneficiaries to a qualified family member* — blood relatives and relatives by marriage and adoption — as many times as necessary. Additionally, if your child receives a scholarship and you need less from the 529 plan than anticipated, withdrawals from the 529 plan can be taken up to the amount of the scholarship. No penalty is owed for the withdrawal; however, you would still owe ordinary income taxes on the earnings portion.
Another unique aspect of 529 plans is that there’s no age at which funds must be distributed. This means the assets can stay in the plan in perpetuity and continue to grow tax-free. The account owner has the option to withdraw the 529 plan funds for any reason, but the earnings portion of a nonqualified 529 plan distribution is subject to ordinary income tax and a 10% penalty.
Another unique aspect of 529 plans is that there’s no age at which funds must be distributed.
Does my state allow deductions for 529 contributions?
It’s important to explore your resident state’s 529 plan since you may be eligible to receive a state tax deduction for contributions, although this shouldn’t be the only consideration for selecting a 529 plan. You should also consider other items such as plan expenses and investment options when deciding on a plan. Don’t forget to make your tax preparer aware of your 529 plan contributions in the event you qualify for the deduction.
Who should apply for FAFSA?
We recommend every family fill out the FAFSA regardless of income level, since it will determine what you can qualify for in terms of student loans. It’s a fairly quick process — usually an hour or less — and allows you to lay out a roadmap for college funding options. This can lead to potential grants and student loan options that provide flexibility to help pay for your family member’s college education.
Tax credits: What are they, and do I qualify?
There are two tax credits that may help reduce your personal tax bill.
- Lifetime Learning Credit — This can be used for undergraduate, graduate, and doctoral programs. The amount of the credit is 20% of the first $10,000 of qualified education expenses. Note that the credit is contingent on your modified adjusted gross income (AGI).
- American Opportunity Tax Credit — This can be used for undergraduate expenses ONLY. Individuals can claim a maximum of $2,500 per eligible student on qualified education expenses. This credit is also contingent on your modified AGI.
Will federal student loans be forgiven?
President Biden initially stated his intention for the government to forgive up to $10,000 of federal student loans. This proposal made it more attractive for individuals to utilize federal student loans with the prospect of having a portion of them forgiven in the future. However, student loan debt forgiveness wasn’t included with the recent $6 trillion dollar budget President Biden released, so it seems unlikely this will become a reality in the near term. Keep in mind that the political environment is always changing, and the issue could be revisited in the future.
With rising college costs and growing concerns around funding higher education expenses, it’s crucial to consider funding strategies and options early on so you can integrate them into your family’s overall financial plans.
As always, if you have any questions about planning and budgeting for a family member’s college education, feel free to reach out — we’re happy to help.