Paying for College

School’s Out for Summer … But Tuition Is Back in the Fall

Giving the gift of education never goes out of style. Here are some different options for helping out the young person in your life.

I can only imagine the enthusiasm of students and teachers who will finally able to be back in a classroom and learning in person as schools and campuses around the country start coming back to life this fall. As I walked around my neighborhood every morning earlier this spring, front lawns were dotted with signs pronouncing “Congratulations, graduate!” for kindergartners, fifth-graders, high school seniors, college grads and every grade in between as families celebrated these important milestones.

The experience of the pandemic has reminded us just how important and irreplaceable educational experiences are for our future generations. For those thinking about giving the gift of education to a young loved one, there’s never been a more meaningful time.

There are a few ways to make a gift that can be used for education, each with its own set of features you should evaluate thoroughly before deciding upon the right vehicle to use.

The Education-Specific Option

If you want to ensure your gift is used strictly for education, there are two common ways to do so. The first and most straightforward way is to directly pay for the student’s education by writing a check for their tuition payable to their educational institution. Paying for tuition in this way is an efficient way to give, as this type of support does not count toward your annual gift tax exclusion amount ($15,000 per person in 2021) or your lifetime exemption amount ($11.7 million per person) as long as the check is made payable directly to the education institution.

While writing a check is an easy way to pay for tuition due, many parents or family members start thinking about how to save for future college costs as soon as the future college student is born. One of the most popular methods to save for future educational expenses is the 529 savings plan. A 529 savings plan is a tax-advantaged account that can be used to pay for qualified education costs. Once a 529 savings plan is opened, anyone can contribute to it on behalf of a beneficiary.

While there is no federal income tax deduction for making a contribution to a 529 savings plan, some states do offer a state income tax deduction for contributions made by a resident to their state plan. The account, once invested, grows tax-deferred each year until the student goes to college. Withdrawals from the account are tax-free as long as funds are used to pay for qualified educational expenses. (The important word here is “qualified,” as some costs, such as application fees or transportation costs, do not fall into the qualified category.) Some examples of qualified education costs include:

  • Tuition and fees for a single college or university
  • College room and board, books and supplies, computers and internet access
  • Registered apprenticeship program expenses
  • Tuition and fees for K-12 schools up to $10,000 per year
  • Up to $10,000 in student loan debt repayment

Keep in mind, however, that if the funds are withdrawn for a reason other than the educational uses noted above, income taxes and a 10% penalty will apply to the growth in the account.

Since a 529 plan account is generally established for the benefit of another person, any money you contribute counts as a gift to that person, so your contribution is a great way to utilize your annual gift tax exclusion amount. You can give the full $15,000 each year to a single beneficiary, or $30,000 if you are married and your spouse also contributes. You could also take advantage of a special rule and do a lump sum contribution by accelerating up to five years of your annual gifts all at once — $75,000 if you are single or $150,000 if you are married. A lump sum investment of $150,000 to a 529 savings plan when a child is born would be worth more than $350,000 by the time they turn 18 if the account compounds at 5% each year.

Some families worry about overfunding a 529 account for their child or loved one. If your loved one doesn’t go to college or college ends up costing less than you originally anticipated, one of the great features of a 529 plan is that you can change the beneficiary on the plan to another family member of the original beneficiary. Parents can change the beneficiary to another child, a cousin or even themselves!

A 529 prepaid tuition plan is another way to pay for college, though not quite as common as the more traditional 529 savings plan described above. With a prepaid tuition plan, you prepay future costs at a specific college or university, locking in future tuition costs today regardless of how many years are left until actual enrollment. 

The More Flexible Option

There are other ways to financially support a loved one’s education without putting money directly toward tuition costs. Trusts and custodial accounts are a great way to build in flexibility.

By setting up a trust, the trustee can specify what they want the money to be used for, all of which would be clearly laid out in the terms of the trust. For example, you may specify that it be for education-related expenses, such as housing, meals, transportation, internships or textbooks. The trustee may also specify when the money can be accessed by using an age limit or creating terms for the money to be distributed over a specific period of time, for example. For those making the gifts, trusts offer greater customization and flexibility than a 529 savings plan offers. However, trusts do come with higher legal costs to set up and administer as well as less favorable tax treatment, as trusts do not provide tax-free growth or distributions like 529 savings plans do.

A custodial account offers a similar structure to trusts, though they’re easier and less costly to establish. Unlike trusts, however, once the beneficiary reaches the age of majority, the account becomes theirs. They will be able to take control of the account and use the remaining funds for whatever purpose they like – whether it is next semester’s tuition and books or the new car they have their eye on.

Similar to 529 plans, contributions to both trusts and custodial accounts for the benefit of another person count as a gift to that person, so you will need to file a gift tax return. If you are considering using a trust or custodial account, the beneficiary may be subject to Kiddie Tax rules, so take this into consideration when evaluating your options.

The gift of education, no matter how big or small, will make a lasting difference in a loved one’s life. Ultimately, however you decide to make this gift, know that there isn’t a wrong way to do it!

About the Author

Kathleen Kenealy, CFP®, CPWA®

Senior Wealth Adviser, Boston Private, an SVB company

Kathleen Kenealy, CFP®, CPWA® is the Director of Financial Planning and a senior wealth adviser for Boston Private, an SVB company. She specializes in working with successful individuals and families to manage, protect and grow their assets. Kenealy provides guidance on investment, retirement, philanthropic, estate and tax-planning strategies.

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