By Todd J. Preti

One of the largest expenses for a family is higher education expenses for their children. Education expenses continue to grow faster than inflation. This reality has resulted in even families with significant means having to plan for the future. The average cost of college tuition and fees exceeds $34,000.00 per year for private schools and almost $12,000.00 per year for in-state residents at a public school. These expenses do not even include room and board. The best way to address these costs is to implement a plan far in advance.

The most common forms of education savings accounts are a 529 Plan and a Uniform Transfers to Minors Act (UTMA) account. Anyone can establish a 529 Plan – parent, grandparent, aunt, uncle, etc. However, you need to check your specific state of residence to determine if you are able to utilize the tax benefits. The owner of the 529 account controls the funds and can name or change the beneficiary. The major benefit of the 529 Plan is the growth on investments is tax free and Virginia residents get an in-state tax deduction.

Assets in a 529 Plan can be withdrawn and used free of taxes for qualified post-secondary education expenses (room, board, tuition) and with the new law, for some K-12 expenses. As of 2018, a family can use up to $10,000.00 in a 529 Plan for K-12 educational expenses. If the account owner is the parent then the 529 Plan assets are considered parental assets for FAFSA. The UTMA account becomes the assets of the child when they reach the age of majority (18 or 21). The gains on investments are taxable income. The major benefit of a UTMA account is the account owner has more flexibility on the use of the funds, including non-educational expenses.

The contribution to a 529 plan may allow the owner of the plan to take an in-state tax deduction. Each state is different regarding the amount of the state tax deduction. Also, each state has set a cap on the total amount of contributions a person can make to a 529 Plan per beneficiary.

A child who receives money from a 529 account established and the owned by someone other than their parents (i.e. grandparents) is considered income for FAFSA purposes. As such, a student should consider using the 529 assets later in their educational career. Also, a person can make a lump sum gift to a 529 Plan of $75,000.00 and it will be treated as a $15,000.00 annual gift for each of the next five year for gift tax purposes and will not reduce the donor’s unified credit of $11,180,000.00.

The direct payment of college tuition by a parent/grandparent is not subject to the annual gift tax limits ($15,000.00 - single or $30,000.00 - spouses). Combining a 529 gift with a direct tuition payment allows for a greater non-taxable contribution to the student. This planning is most helpful to people looking to reduce their estate.

In addition to the 529 plans and UTMA there are other options a family may have to pay for education expenses. These options include the following:

  1. The American Opportunity Tax Credit. This credit allows for a maximum tax credit of $2,500.00 for actual education expenses paid but cannot include expenses paid by a scholarship or 529 assets. Also, there is a phase out for families with adjusted gross income of $160,000.00 to $180,000.00 (over $180,000.00 not eligible).
  2. The Lifetime Learning Credit. This credit is for 20% of qualified education expenses up to $10,000.00 per year for the taxpayer. This credit is only available to individuals with incomes below $65,000.00/$130,000.00 and a phase out at $55,000.00/$110,000.00.

The American Opportunity Tax Credit and the Lifetime Learning Credit cannot be used together so you need to plan accordingly.

It is very important to know the rules on what expenses will qualify under a 529 Plan so as to avoid withdrawal penalties. Using 529 Plan assets for non-qualified expenses can cause taxes and penalties. Withdrawals must only be taken for the beneficiary who incurred the education expense.

Many educational expenses will qualify for 529 plan withdrawals (like room, board, tuition and books) but if the student is living off campus then it is important to understand that the cost of rent is limited to the housing expenses stated by the college’s financial aid department.

It is also important to keep accurate records of all expenses paid in case the State or IRS ask for proof. It is the author’s experience that the IRS does not have a good system to track college expenses paid or for taxpayers to adequately identify the allowable college expenses on their 1040 tax return. If the IRS asks for proof make sure you can provide it or be ready to pay the tax penalty.

While educational expenses are significant and continue to grow there are opportunities for families to be in a better position to pay these significant but important costs. If you have questions or if we can assist you please call the attorneys at Midgett Preti Olansen PC.