If you have created your Will or Trust as part of your estate plan, you’ve already taken a big step toward the financial well-being of your family members. However, you could go further by planning for specific future expenditures, such as paying for your children (or grandchildren) to get the best possible education.
While you could earmark a portion of your retirement funds or your beneficiaries’ inheritances to be used for education, it’s not necessarily the wisest way to save for college tuition. Let’s explore more effective ways to safeguard your hard-earned funds—and ensure they’re spent as you intended.
Smart Options for Parents and Grandparents Starting a Child’s College Fund
No matter which planning option you choose, your beneficiary’s future college fund shouldn’t be in cash. Whether in a dedicated bank account, an insurance policy, or a jar on a shelf, those funds are always at risk of being used to pay for something else—and could potentially be spent by someone other than the student. Any of the following education savings accounts offer far more protection from spendthrifts, legal actions, theft, or even an impulse buy.
These plans, named for Section 529 of the Internal Revenue Code, are a common way for parents to cover college costs. A 529 plan can be used for K–12 education and some student loan debt, and many offer ongoing contributions directly from your bank account.
The popularity of 529 plans comes from their tax-saving advantages. The funds contributed to a 529 account are tax-deferred, and withdrawals are tax-free as long as they’re used for qualified education expenses. There are also no limits on contribution amounts, allowing your offspring the freedom to attend even the most elite (expensive) institutions.
That said, there are some potential problems with 529 plans. If the money isn’t used for eligible expenses—such as tuition and fees, books, computers, or room and board—the funds become subject to tax plus a 10% penalty. If your child decides not to attend college, the entire account is subject to taxation and penalty. The plans also limit where and how you can invest your money, mainly in a small selection of mutual funds. Finally, your contribution could trigger federal gift taxes if it exceeds the annual exemption limit.
Education Savings Accounts (ESAs)
In 2023, Florida became the largest state in the nation to adopt Education Savings Accounts (ESAs) for parents to pay for the costs of a child’s education. These publicly-funded accounts can be used for K-12 private schools, college tuition, tutoring, supplies, and other learning costs. Like 529 plans, withdrawals are tax-free when used for eligible expenses.
ESAs have lower annual contribution limits than 529 plans and place limits on income levels and beneficiary age. However, they offer more flexibility in some areas, such as allowing self-directed investments. An ESA could be an ideal supplement to your 529 plan, giving kids going off to college a safety net if sudden expenses crop up.
If you want to preserve your relative’s eligibility for financial aid, you might want to save for your child or grandchild’s education using an education trust. An irrevocable education trust holds your child’s college fund, and the trustee can invest the funds to grow the balance.
Since the money in the trust isn’t counted toward your financial resources, your college-bound children can apply for financial aid—which is usually impossible with a 529 plan. An irrevocable trust also has advantages for parents, as it protects your assets while preserving your eligibility for public benefits later in life.
A trust is a powerful tool, but only if it’s structured correctly. For example, you should closely monitor the amount you contribute each year to stay within the annual gift tax exemption. You also need to appoint someone you trust to create more income through investments (and determine when your beneficiaries can remove and replace the trustee if something goes wrong).
Get a Personalized College Fund Plan from a Trusted Estate Planning Attorney
Saving for your child’s college education is a noble financial goal, but your intentions could have unintended consequences without the right legal advice. Schedule an intro call or firstname.lastname@example.org with Yolofsky Law today so we can help you continue to provide for your children and grandchildren for years into the future.