Coordinate Saving for College with Your Estate Planning

During our estate planning discussions, parents and grandparents often tell us about their hopes and dreams for the next generations of their families. Helping children and grandchildren achieve their full potential often includes helping them pay for additional education after high school.

With higher education costs on the rise, most people will need to save for these expenses. Starting your savings plan early is key. Another key is coordinating your college savings plan with your estate and tax planning since there are plenty of tax benefits to saving for the next generation’s education needs.

Keep in mind that for most of your saving options, the assets in the savings vehicle will be considered to be an asset of the student on their Free Application for Federal Student Aid (FASFA) form and could affect their eligibility for financial aid or the amount of financial aid for which they qualify.

529 Plans Are a Tax-Efficient Savings Choice

529 plans coordinate well with estate and tax planning, because

• You can fund them with annual exclusion gifts, which are not subject to federal gift tax. For 2022, the annual exclusion (the tax-free amount you can gift to each person per year) is $16,000 per donor or $32,000 per married couple making a gift.
• You can “front-load” a 529 plan in one year with up to five years’ worth of annual exclusion gifts, meaning up to $80,000 from a single person or $160,000 if you are married.
• The growth of the assets within the plan is not subject to income tax.
• Some states, including Michigan, allow you to deduct the amount paid into the plan each year from your state taxable income (up to the state’s deduction limit).

Family members have two options for a 529 plan:

1. 529 prepaid tuition plan. These plans, like the Michigan Education Trust (MET), allow you to purchase future tuition credits at today’s cost. The plan covers the tuition and fees (but usually not room and board) when the student later attends an in-state, public college or university.
2. If the child doesn’t attend college or receives a scholarship, the credits can be transferred to another family member or your contributions can be refunded to you, although subject to a penalty.
3. Students can attend an out-of-state or private school but will have to pay the difference between the more expensive tuition and the average in-state, public school tuition.
4. 529 savings account. These plans, like the Michigan Education Savings Program (MESP), allow you to place funds in one or more investment accounts and then use the funds for the beneficiary’s higher education expenses. Your account growth is based on the performance of the investment option(s) you select, so these plans have investment risk. 
5. Distributions from this account will not be taxed as long as they are used solely for “qualified higher education expenses” such as tuition, room and board, books and computers.
6. Money that is disbursed from the account but not used for qualified education expenses is subject to federal taxes and at least a 10% penalty. However, unused funds may be transferred to and used by an eligible member of the beneficiary’s family.

Less Conventional Options to Save for Education Expenses

Depending on your tax or estate planning goals, other saving options might coordinate well. Like 529 plans, these options can be funded with annual exclusion gifts:

• Gift trusts. Generally, irrevocable gift trusts are an excellent customizable tool used to save for educational expenses, allowing the grantor to select the purposes for which the funds can be used and at what age the beneficiary may withdraw the assets. The income earned by the trust assets is subject to trust income tax rates, and the grantor should not serve as the trustee.
• Section 2503(c) minor’s trust. This is a specific example of a more complex gift trust that has only one beneficiary and can be structured to allow the beneficiary to choose whether or not to exercise their right to the assets at age 21. Gifts to these trusts qualify as annual exclusion gifts so long as the beneficiary is under age 21. Distributions from this trust may be narrowly tailored for education purposes, or authorized for broader purposes, but trust assets may only be used to benefit the designated beneficiary. The income earned by the trust assets is subject to trust income tax rates, and the grantor should not serve as the trustee.
• UTMA (Uniform Transfers to Minors Act) or UGMA (Uniform Gift to Minors Act) custodial account. These accounts are created pursuant to state law to hold gifts made to a minor and are managed for the minor by a custodian. The custodian of the account may be, but is not required to be, the child’s parents or a person gifting assets to the account. Ownership of this account must be transferred to the child at a specific age (usually at age 21, but this age varies by state). The assets in this account do not have to be used for education, but they may only be used to benefit the designated beneficiary. Income earned on the account’s assets is taxed to the beneficiary but in some instances could be taxed at the parents’ rate.  

Getting Started With a College Savings Plan

It is never too early to start saving, or to realize that your estate planning attorney can help you choose a plan that will meet your savings goals over time and avoid unintended tax consequences.