As someone who is still paying off my student loans, I’ve made saving for my children’s college education a priority in my household. My husband and I put away $200 per month for our two kids into a 529 account, and our own parents contribute on the kids’ birthdays.
But what’s the most efficient way to save for college when multiple people want to help multiple kids build their college savings? Here are some questions to ask yourself to help you decide how to manage multiple college savings accounts.
How many accounts do you need?
If you’d like to save for several children in one college savings account, you can technically do that by changing the beneficiary on the account as needed. For instance, with 529 plans and Coverdell Educational Savings Accounts (ESA), you can have your oldest child listed as the beneficiary initially, and if they don’t use all the funds or decide not to go to college, you can switch the beneficiary to the next child going to college.
“On the one hand, having one fund for all the kids that everyone contributes to keeps things simple, and it might be easier to manage the investments and distributions of just one account,” says Jenny Raess, CFP®, Advice Integration Lead at Northwestern Mutual. On the other hand, this may not make sense if you have children close in age.
For starters, you can only take distributions for one beneficiary, so you won’t be able to take out money for both children from the same account if they are in college at the same time. Even if your kids don’t overlap, you’ll have to be more mindful about how much in distributions you take out for each child — if your children are close in age, you won’t have a lot of time to build your savings for your next child if you take out more than you intended for the first.
How much do you and your relatives want to help save each year?
How much you think you’ll want to save and how much others plan to contribute each year for your children should factor into what type of account or how many accounts you decide to open. A Coverdell savings account, for instance, has a contribution limit of $2,000 per year, so if a lot of people will be contributing to your kids’ college savings, then you may want to consider a 529 plan instead, Raess suggests. Also, your contribution to a Coverdell starts to phase out if you make above certain IRS-specified income limits.
529 plans don’t technically have contribution limits, although contributions are considered gifts that fall under gift-tax exclusion laws (for 2022, individuals can gift up to $16,000 a year per person without having to file a gift-tax return form). So having a 529 account for each child means you and your spouse (or any family member who wants to contribute) can each give each child up to $16,000.
A special rule with 529s also allows you to frontload up to five years’ worth of the annual exclusion amount at once without incurring the gift tax. But in deciding how much to set aside for college, be sure to talk to a financial advisor to understand how much you can give without sacrificing important financial goals for yourself, such as retirement, Raess says.
How much control do you want over the distributions?
When considering if you should use a 529 plan, a Coverdell ESA, or some other type of account to help save for college, a big variable is how much control you want over how the funds are distributed, and what happens if the funds aren’t used for higher education.
“With a 529, you’re the owner, as a parent, so you can decide how to make those distributions,” Raess explains. Plus, if your children don’t use up the money for college, you could change the beneficiary to another relative or even to yourself (any funds not used for qualified higher education expenses will likely require you to pay taxes and a penalty).
With a Coverdell, you can change the beneficiary or rollover any unused funds to a new Coverdell or 529 — but the money must be used or withdrawn by the beneficiary’s 30th birthday, and any funds not used for higher education will also be subject to taxes and penalties. Custodial accounts for minors, like the Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA) accounts, can be used for college costs but aren’t explicitly for college. UGMA and UTMA funds technically belong to the minor, not the custodian of the account, so kids will get control of the account once they reach adulthood.
How will the account affect financial aid?
“To maximize savings, you might consider positioning the assets in a way that, should the child need to get financial aid, they’re still able to get as much as possible,” Raess says.
This means understanding how the accounts you have might impact the financial aid formula used by colleges. A student’s assets are factored into the formula at a much higher rate than parents’ assets are — in other words, the greater the assets a child has, the more their college aid could be reduced.
A 529 owned by a student or by a parent with the student as a beneficiary is considered the parents’ assets. Currently, while the assets within a 529 owned by a grandparent or other relative don’t have to be reported on the FAFSA, any distributions from that 529 count as cash support for the student, which is reported. The good news is that an upcoming change to the FAFSA rules starting with the 2024 to 2025 school year will mean students won’t have to report cash support on the FAFSA.
Custodial accounts, like UGMAs and UTMAs, count toward the student’s assets.
What are the tax breaks, if any, on your accounts?
It’s also important to look at the tax implications of your contributions and withdrawals when considering which accounts, or how many, you want to have.
Owners of 529 accounts — whether parents or relatives of the child — can often get a state tax deduction or credit on their contributions if they own an account from their home state, Raess says. Some states even allow tax deductions for 529 contributions to other states’ plans. But, “if you just have a grandparent giving a parent money for the account, that will likely not get that tax deduction.”
As stated earlier, contributions to 529 plans are considered gifts and therefore subject to gift-tax rules for the account holder. However, a beneficiary change from one generation to the next can actually trigger gift taxes for the beneficiary — such as when a 529 account holder changes a beneficiary from their child to their grandchildren. “It’s seen as the current, older beneficiary making a gift of that account value to that younger generation beneficiary,” Raess says. “That’s just a consideration, too, if you’re looking at having just one account for kids or grandkids.”
Withdrawals from a 529 plan are federal-tax-free as long as the money is used for qualified education expenses; otherwise, you must pay taxes and a penalty. Whether or not you pay state taxes will depend on your individual state’s rules. Investment gains from an UTMA or UGMA are taxed in tiers, first at the child’s rate and then at the parents’ rate.
To decide how to save for college in a tax-efficient way, talk to your tax and financial advisors to understand how using these different accounts can impact you and your child’s overall tax picture.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.
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