Saving for college can be challenging. Yet, strategies designed to help get financially prepared can create options beyond relying just on grants, loans, and scholarships.
Offering insight on the topic is Brenton A. Hamlet, senior vice president for Merrill Lynch Los Angeles, works closely with families with college-bound kids of all ages to help make sure when the time comes, they are financially ready.
Q: How can families start a college savings?
A: Saving for college can be not just for parents, but also grandparents and kids themselves to some extent. For example, in working with clients who are grandparents, we discuss the advantages of opening a 529 account benefitting their grandchildren that may also have state tax benefits, in addition to making an annual gift that may have estate tax exclusions for family members. Income-earning teens can also help contribute regularly to a Roth IRA – a special type of tax-advantaged individual retirement account – for future educational costs. And this is not just for wealthy families, these are options for working families who may not have accumulated wealth to realistically build a college savings fund.
I also encourage families to apply for federal student aid, even if they don’t think they will qualify, by filling out the online Free Application for Federal Student Aid (FAFSA). Many don’t realize that financial aid awards don’t just look at income, but also additional factors such as how many children you’ll be sending to college, cost of the college and your child’s year in school. Students may also qualify for scholarships or grants, usually based on academic achievement.
Q: What are some of these different types of college savings accounts?
A: Various federal income tax provisions have been set up not only to encourage people to set aside funds for higher education, but to help offset some of the costs. Two of the most popular types of plans are 529 plan accounts and Uniform Gifts to Minor Act and Uniform Transfer to Minor Act — or UGMA/UTMA — accounts.
A 529 plan is a tax-advantaged account used to save and pay for qualified education expenses such as tuition, room and board, books and laptops at an accredited institution. These accounts grow tax free and may have additional state tax benefits as well. 529 plans also allow for a five-year contribution made in a single year – as much as $85,000 for a single gift and $170,000 for a married couple – without incurring federal gift tax. Such a lump sum upfront can make a meaningful impact as the funds compound over time. Also notable is that 529 plans can now be used for pre-college private school costs up to $10,000 per year.
Unlike a 529, a UGMA/UTMA account is a taxable account used to save on behalf of a minor to be used for any purpose. For example, the student can use the account to pay for meals, gas and other expenses — even purchasing a car or cell phone. UGMA/UTMA have similar provisions to help family members and others who contribute from paying a gift tax.
Q: I understand there are new tax laws for some college savings accounts starting in 2024?
A: Yes, starting in 2024, new legislation gives 529s greater flexibility. Effective for distributions made on or after January 1, 2024, unused portions of a 529 education account can be rolled over to a Roth IRA without federal taxes or penalties, to help the beneficiary start saving for retirement. This is applicable for 529 accounts that have been open for at least 15 years and a Roth IRA in the same name as the 529 beneficiary, and for accounts that do not exceed the annual contribution limit. There are, however, limits as to how much can be rolled over.
Q: What happens to the education accounts if a teen decides they don’t want to go to college?
A: As we discussed, the new federal tax changes effective next year allows for the transfer unused education savings in a 529 plan into a Roth IRA for that same beneficiary without tax penalties. Additionally, if a beneficiary, such as the student, decides that a traditional college may not be the route for them, account holders can change beneficiaries to another qualifying family member including in-laws, aunts, uncles, cousins or even to parents who want to go back to school. Also, some education accounts such as the 529 can be used for the costs of vocational training through an accredited apprenticeship program.