Planning to pay for higher education expenses is as important as it is overwhelming. One reason people should plan on saving for college as early as possible is because college tuition has increased significantly in the past 20 years, more than any good or service other than healthcare†.
You and your advisors should consider multiple options when selecting the right vehicle to assist your family in meeting specific savings goals. Here are a few of the most common education savings accounts that individuals benefit from.
529 accounts
529 accounts are one of the most popular tools for education funding because of the income tax advantages. You make contributions to the account, which are then invested for growth with no income tax. Funds distributed from the 529 account are tax-free if they’re used for qualifying educational expenses. Although you can use the 529 funds for non-qualifying educational expenses, portions of those distributions may be subject to both ordinary income tax and a 10% penalty.
Each state other than Wyoming offers a 529 plan with different investment options available. Depending on your state of residency, you may be eligible for a deduction on your state tax return for making contributions.
An example: An Ohio resident in 2023 could take a state tax deduction (up to $4,000, per beneficiary, per year) for contributions to any state’s 529 plan. Prior to 2023, to be eligible for the Ohio state tax deduction you had to contribute to the Ohio 529 plan. Be sure to notify your tax professional of your contributions as rules vary from state to state and year to year.
Be aware that historically 529 accounts owned by a parent or child were considered assets that must be reported on the FAFSA application (Free Application for Federal Student Aid). However, beginning with the 2024-2025 academic year, the Department of Education revised the FAFSA application to consider only the incomes and assets of the student and their parents. Although cash gifts are arguably included as investment assets of the student, grandparents could fund 529 accounts for the grandchild’s education without affecting the student’s financial aid eligibility, so long as neither the parent nor the student were the owners.
Custodial accounts
A custodial account is an investment account established by an adult for a minor beneficiary. The custodian is obliged to manage the account in the beneficiary’s best interest until the beneficiary reaches a stated age, typically between 18 and 25, depending the state of residency. Once the beneficiary reaches the age for termination, they will be the owner of the account. Custodial accounts are always considered the beneficiary’s assets and are reportable on FAFSA applications. Although there are not any specific income tax benefits unique to a custodial account, there is also no requirement that the funds be used for specific educational purposes.
Traditional investment accounts
A traditional investment account is a simple option for saving for college, especially when the savings start closer to the time for college. Realized gains and income on the account will be taxed (unlike 529 plans) but even if the would-be student decides not to attend college, the assets can be used for anything without penalty. There are no funding limitations on an investment account. However, there are no tax benefits for funding education with this account type. If the account is owned by the parent or the student, it will affect the student’s FAFSA filing.
Traditional savings accounts
Like an investment account, a bank savings or money market account is another simple option. Earnings on the accounts may be lower compared to other savings vehicles but they have little to no market risk. Like the traditional investment account, the money can be used for anything without penalty, there are no funding limitations, and no tax benefits. If the account is owned by the parent or the student, it will affect the student’s FAFSA filing.
Roth IRAs for a child or grandchild
Although a Roth IRA is traditionally used as a retirement funding vehicle, it can also be used in an educational savings plan. In general, withdrawals from Roth IRAs are tax free after the IRA owner turns 59 ½, including any investment returns earned on their original contributions. Roth IRA assets can be used at any time–even before the IRA owner turns 59 ½ –to fund education expenses for the account owner, their spouse, children, or grandchildren without incurring a 10% penalty that would normally apply. However, for pre-59 ½ distribution–even for educational expenses–any earnings will be taxable.
Planning Tip: Ask your tax and legal advisors about the benefits of withdrawing Roth IRA assets when your dependent is within two years of graduation. The current FAFSA rules look back at income over the prior two years, so triggering income late in the game may not affect financial grants.
529 to Roth conversion
Beginning in 2024, the custodian of a 529 plan will have the opportunity to convert the 529 to a Roth IRA for the 529 beneficiary without triggering extra income taxes or penalties. There are some specific requirements that need to be met to permit such a conversion:
- The Roth conversion is only available for funds in 529 accounts that were created more than 15 years before the date of conversion, and only as to funds that were contributed more than five years prior.
- The converted funds must be moved from the 529 into a Roth IRA for the designated beneficiary.
- The existing Roth IRA contributions rules for the beneficiary still appear to apply, including total annual contribution limits for the beneficiary, and the requirement to have earned income at least equal to the amount converted.
- Each 529 beneficiary has a total lifetime conversion limit of $35,000.
Although the statutory provisions are in place, the IRS has not yet released regulations associated with the program. Those regulations, when in effect, may change how some of these restrictions are interpreted. State laws may have impacts that differ from federal law.
Getting the advice you may need
We are here to help you navigate the many options and complexities of saving for college. Work with your estate planning team to determine which approach is right for you. To learn more, please contact your Huntington Private Bank team to see how we can help, or find a Huntington Private Bank Office near you.
