Main Office: 650.377.4108
1510 Fashion Island Blvd. Ste. 210
San Mateo, CA 94404
One of the biggest investments a parent may make in a child’s life will be in their education. One thing we all know is that college is expensive and that can put a burden on many families. Many parents and grandparents want to save through an investment that will help them to achieve their goal while still allowing them control and flexibility.
This overview will provide the benefits as well as the drawbacks of the 529 Savings Plan, Coverdell Education Account, and Roth Individual Retirement Accounts (IRA).
Every state offers a 529 education savings plan and can be used anywhere in the United States as well as some international schools. That means that you are not stuck to your state’s plan and you can research all of the in-state and out-of-state 529 plans available to you. 529 Plans are the most popular plans for college savings since earnings grow tax free when used for college. Some states even provide residents income state tax benefits.
One of the benefits of the 529 plan is that there are no income limits so anyone can contribute. Many plans allow grandparents, relatives, and friends to make a direct contribution to the account on behalf of the beneficiary. There is no annual contribution limit but there are lifetime contribution limits that range from $235,000 to $400,000 depending on the plan. The 529 plan has favorable gift tax treatment since contributions qualify for the annual gift exclusion (currently at $15,000 per person and $30,000 per couple) and even allows up to 5 years of aggregated gifting (up to $75,000 per person and $150,000 per couple) without needing to be reported on a gift tax return. From an estate planning perspective, this is a great savings vehicle for grandparents.
The account “owner” (usually the parent) maintains control of the account. So if the “beneficiary” (usually the child) does not attend college, they do not have access to the funds. In fact, the owner can change the beneficiary to another family member.
If the account is not used for college expenses, withdrawals of earnings will be taxed as ordinary income and incur a 10% tax penalty. The return of contributions will not be taxed nor penalized.You have the choice of selecting one or more 529 plans. Some states offer an advisor-sold plan where a financial planner can help you and other states only offer a direct-sold plan. Some states offer state residents a tax benefit whereas other states do not. Researching your state’s plan and comparing it to other states will be the only way to determine the best plan for you. When comparing plans you also want to evaluate performance and fees.
Many parents choose to fund their child’s education with a 529 college plan because assets held in the parents or students name count very little when applying for financial aid. In fact, only 5.64% of the balance is included as compared to assets held in a child’s name where 20% may be counted against financial aid. The amount your family is expected to pay is called the expected family contribution (EFC) and is based on the information provided on the FAFSA. Based on this formula, student owned assets have a greater reduction in financial aid, thus making parent-owned assets more attractive to savers.
Grandparent and non-custodial owned 529 plans may not have the asset counted against the child when applying for aid; however, withdrawals will be counted as untaxed income on the Free Application for Federal Student Aid (FAFSA). This could have an even greater impact on financial aid and what is expected to be the family contribution in future years. FAFSA looks at the prior-prior year income so using the assets towards the later years of college would be most beneficial. If divorced, only the custodial parent’s income and assets are reported on FAFSA- meaning a withdrawal counts as student income and up to 50% of the amount withdrawn counts towards EFC. Changing ownership from the non-custodial parent to the beneficiary/student can be considered.
When taking withdrawals from a 529 plan, consider tax credits and deductions you may qualify for. Qualified education expenses do not allow for “double- dipping” so you can’t use the same expenses to take the American Opportunity Tax Credit or Lifetime Learning Credit. For more information about these credits, go to http://www.finaid.org/otheraid/tax.html. Once your children are headed to college, it is time to consider 529 withdrawal strategies to best coordinate withdrawals with the credits.
Starting in 2018, the tax overhaul now allows you to withdraw up to $10,000 from a 529 plan for private and religious-school tuition from Kindergarten through 12th grade. For more information, go to “New tax law brings big changes to 529 plans” http://www.savingforcollege.com/articles/coming-soon-big-changes-to-529-plans. AccessedJanuary 8, 2018.
The Coverdell ESA is another great vehicle to fund a child’s education and allows a parent the option to fund K-12 in addition to college expenses. These accounts do not have to be sponsored by a state so there is flexibility with investment options.
Coverdell ESA’s are held in trust for the child and the “responsible individual” is the parent who makes decisions on behalf of the child. The bank or financial institution is the custodian which does not allow the parent to maintain control of the account like the 529 Plan does; although, the beneficiary may be changed until the child assumes control of the account. The parent may assign control to the child at the age of majority (age 18 or age 21) in most states but is not required to do so until the child is age 30. However at the age of 30, unused funds will be distributed, taxed, and earnings penalized at 10%. Again, remember that assets held in a child’s name has a higher impact on financial aid than that same asset held in the parents name.
Unlike the 529 Plan, there are no state tax deductions for contributions to a Coverdell ESA. A maximum contribution allowed is $2,000 per beneficiary by all sources and can be phased out by income limit thresholds. All contributions must cease once the child turns 18. Just like the 529 plan, earnings grow tax free from federal tax if withdrawals are used for qualified expenses. Again, there is no “double-dipping” so planning your withdrawals along with any tax deduction and credits in mind will be very important.
The FAFSA will count 5.64% of the Coverdell ESA owned by the parent or dependent student. Withdrawals will not count as student income on the FAFSA. If a grandparent or third party owns the account, student income may increase to 50% and the EFC will increase.
When retirement goals still need to be met, adding a Roth IRA to the mix provides flexibility. Retirement accounts such as 401(k) and IRAs do not count towards the EFC for financial aid.
In a Roth IRA, the amount contributed (principal) can be taken tax and penalty free meaning you can take that portion out to pay for college. When a withdrawal is made, principal always comes out first and then earnings are withdrawn. To qualify for tax-free and penalty-free withdrawals on earnings, you must be over age 59 ½ and meet the 5 year holding requirement. If under age 59 1/2, withdrawals on earnings will be subject to ordinary income tax. You may be able to have the tax penalties waived if used for qualified education expenses and the Roth IRA meets the 5 year holding requirement. The distribution must occur during the same year in which the expense occurred.
Another consideration is that withdrawals from a Roth IRA are considered untaxed income that must be reported on the FAFSA, increasing the EFC. The prior-prior year income reporting does help in strategizing withdrawals in later college years.
The maximum annual contribution is $5,500 per year and $6500 if over age 50. Contributions made to a ROTH IRA are based on your modified adjusted gross income and reduced by income limit thresholds like the Coverdell ESA versus the 529 plan which does not apply an income limit to contribution eligibility. If eligible to contribute, you have until the tax filing deadline (2017 is 4/17/2018).
Maritza Rogers is a registered representative of Lincoln Financial Advisors Corp. Securities and investment advisory services offered through Lincoln Financial Advisors, a broker-dealer (member SIPC) and registered investment advisor. Athena Wealth Strategies is not an affiliate of Lincoln Financial Advisors Corp. CRN1988417-010818
Securities and investment advisory services offered through Lincoln Financial Advisors, a broker-dealer (member SIPC) and registered investment advisor. Insurance offered through Lincoln Marketing and Insurance Agency, LLC and Lincoln Associates Insurance Agency, Inc. and other fine companies. Athena Wealth Strategies is not an affiliate of Lincoln Financial Advisors Corp. CRN1378341-122215
We are licensed in the following states. If you are a legal resident of one of these states, please proceed. We are sorry if we are unable to offer you our services at this time.
Securities: Alabama, Arizona, California, Colorado, Connecticut, Delaware, Florida, Georgia, Hawaii, Indiana, Maryland, Massachusetts, Missouri, Montana, Nevada, New Jersey, New Mexico, New York, North Carolina, Oregon, Texas, Virginia, Washington, Washington D.C. and Utah.
Unless otherwise identified, Associates on this website are registered representatives of Lincoln Financial Advisors Corp. Securities and investment advisory services offered through Lincoln Financial Advisors Corp., a broker/dealer and a registered investment advisor. Member SIPC. Insurance offered through Lincoln affiliates and other fine companies and state variations thereof. In CA, insurance offered through Lincoln Marketing and Insurance Agency, LLC and Lincoln Associates Insurance Agency, Inc. and other fine companies. Lincoln Financial Group is the marketing name for Lincoln National Corporation and its affiliates. Firm disclosure information available at www.LFG.com. Athena Wealth Strategies is a marketing name for registered representatives and investment advisor representatives of Lincoln Financial Advisors. CRN2995395-031320
See Lincoln Financial Advisors (LFA’s) Form CRS Customer Relationship Summary, available here, for succinct information about the relationships and services LFA offers to retail investors, related fees and costs, specified conflicts of interest, standards of conduct, and disciplinary history, among other things. LFA’s Forms ADV, Part 2A, which describe LFA’s investment advisory services, Regulation Best Interest Disclosure Document, which describes LFA’s broker-dealer services, and other client disclosure documents can be found here.
Julie VanTilburg, CA Insurance License #0C21028; Maritza Rogers, CA Insurance License #0E50369; Robin Starr, CA Insurance License #0G64012; Jeffrey Better, CA Insurance License #0182274; Kaitlyn Zawada, CA Insurance License #4084200
*Associated persons of Lincoln Financial Advisors Corp. who hold a JD and/or CPA license do not offer tax or legal advice on behalf of the firm.
