A less-taxing approach to funding your child’s education

07/18/2014 12:00 AM

07/11/2014 6:38 PM

When you’re a parent, many of your biggest financial decisions revolve around your children, such as creating a will, purchasing life insurance or funding a college education. As the father of two sons, age 9 and 12, I have taken all those steps, including regular contributions to a 529 college savings plan — a less-taxing approach to funding a child’s education.

With a 529 plan, you can save for the future through a special tax-advantaged account. Those funds will grow tax-free until you withdraw the money to pay for college tuition or other education-related expenses such as tuition, fees, room and board, books and other required supplies and equipment. That’s an important advantage because it allows your savings to compound tax-free — a benefit you won’t get if you simply put the money into a traditional mutual fund or another type of taxable investment.

Another consideration is that you don’t have to pay taxes when you withdraw the money for qualified educational expenses. So you can take out as much or as little money as you need each semester without worrying about the tax consequences. Earnings on non-qualified distributions will be subject to income tax and a 10 percent federal income tax penalty.

A typical 529 savings plan has several investment options, allowing you to focus on the potential growth of those assets if you have a young child, or adopt a more conservative strategy if your child is approaching high school graduation. The funds in a 529 account are considered parental assets on the federal financial aid application (FAFSA). That means they have less impact on potential financial assistance than if the assets belonged to the child.

If your income fluctuates from year to year, for instance, you could adjust your contributions based on what you can afford. Most 529 plans have no income or age restrictions, and can be funded by parents, grandparents or other family relatives, regardless of an individual’s earnings or assets.

Another consideration is that most 529 plans have high contribution limits, typically greater than $200,000 per child. So, if you are considering a private college for your son or daughter, you should talk with your financial advisor and tax professional about opening a 529 savings plan to help cover those costs.

Although 529 plans are primarily designed to help parents pay their children’s college expenses, adults can also take advantage of the plans’ favorable tax provisions.

In fact, if you are planning to go back to school to obtain a bachelor’s degree, a graduate degree or a professional certificate, you could use a 529 plan as a vehicle to help cover those educational costs. Retirees can also use a 529 plan to pay for enrichment courses, continuing education or a life-long learning programs that qualify under the tax codes.

As the owner of a 529 plan, you have control over your accumulated assets. That means if a son or daughter decides not to go to college or enroll in a professional training program, you can designate another child as the beneficiary of the funds or use them for your own education. That gives you more flexibility than funding an account for your child under the uniform gifts to minors regulations, where the child receives the funds at a certain designated age, whether or not the child goes to college.

Affluent parents and grandparents should talk with their financial advisors and tax professionals about opening a 529 account as part of their estate planning. Contributions made to a 529 savings plan qualify for the $14,000 annual exclusion from federal gift taxes. That means you can begin funding a significant portion of college costs without worrying about the gift tax. You could also contribute up to $70,000, and declare it as a five-year gift on your tax return. That would reduce your personal estate and provide a solid foundation for your child’s or grandchild’s college costs, while leaving you in control of the assets.

As with any savings plan, it's better to get started now, even with small contributions, than to wait until your child is older. That provides more time for your investment to grow, helping you become better prepared financially for the cost of higher education.

Andrew Menachem, CIMA, is a Wealth Advisor at the Menachem Wealth Management Group at Morgan Stanley in Aventura. Views expressed are those of the author, not necessarily Morgan Stanley, and are not a solicitation to buy or sell any security. The strategies and/or investments referenced may not be suitable for all investors. Follow Menachem on Twitter @AMenachemMS

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