With the cost of college on the rise year after year, continuing education can present a huge challenge for families.
The 2018-2019 average annual tuition and fee prices for in-state students at public four-year colleges range from $5,400 to more than $16,500, according to The College Board, a nonprofit organization aimed at helping students succeed in higher education. Those costs can easily double for out-of-state students and rise even higher for those attending private institutions.
For families anticipating a college education for their children, there’s no question that smart saving—and saving early—is important. Erica Rytilahti, Senior Managing Director of Wealth Management at Trust Point, helps families plan for future education every day.
“Tuition costs have gone up much higher over the last 10 years than inflation rates, so there’s definitely a need,” Rytilahti says. “There are still opportunities out there for scholarships, grants and student loans, but there’s a lot of news about how students are graduating with very high debt loads and family members want to try to alleviate that.”
And when she speaks of family, she means more than just parents. She’s found that more grandparents and other family members, even friends, want to chip in. One way to do that, she advises, is through a 529 plan.
How it Works
A 529 plan can be created at any time and is set up for one specific beneficiary. The account owner can be the grandparent, parent, or even the beneficiary. Once established, anyone can contribute to the account—parents, grandparents, aunts, uncles, or friends. And if plans change, the beneficiary can, too, whether it’s another child or an adult pursuing a degree, as long as they are an eligible family member of the current beneficiary.
To avoid federal gift tax consequences, annual contributions to 529 plans are capped at $15,000 for each contributor ($30,000 jointly for couples), though a larger one-time contribution of up to $75,000 can be made and prorated over five years, helping investors to get a head start.
The federal and state tax benefits are perhaps the best part of a 529 plan.
“It is similar to an IRA in that the assets can be invested and grow tax-free,” Rytilahti says. “And as long as contributions are used for qualified educational expenses—tuition, books, room and board, technology, etc.—withdrawals are also tax-free.”
It’s important to note that if a withdrawal is made for non-education reasons, it will come with a 10 percent penalty tax and incur income tax as well. If a beneficiary does not use all of the plan’s funds, they can always be put toward another beneficiary’s education.
A 529 plan can also be used to reduce your taxable income, since you may be able to use contributions as a deduction on your state tax return depending on your individual tax situation. For the 2023 tax year, Minnesotans can claim up to a $1,500 deduction ($3,000 per married couple filing jointly) against state income tax or a credit equal to 50 percent (but no greater than $500) of the contributions made. In Wisconsin, up to $3,860 per beneficiary per year is deductible.
If someone makes a contribution between $15,000 and $75,000, the ability to prorate that lump sum over five years provides relief from potentially substantial gift taxes as well.
Deciding What’s Best
Though 529 plans are excellent college savings tools, Rytilahti notes that every family is different and Trust Point can work with anyone to determine the best path to accomplish their goals.
For example, she has worked with grandparents who pay tuition directly to a school, which is another nice way to help students while avoiding federal gift taxes. She has also advised families to work with their attorney to establish irrevocable trusts for education, and helped others who used savings bonds for college expenses.
“And obviously the sooner you start the better, so that contributions and earnings can compound,” Rytilahti says. “But, certainly there are benefits even if you start later in the child’s life.”
529 Plan dollars can now also be used for elementary and private school tuition as well, though those expenses are capped at $10,000 a year. Withdrawals for college expenses do not have a limit and can be made anytime.
Balance limits do exist for 529 plans and vary from state to state. For 2023, the maximum balance is $425,000 in Minnesota and $545,500 in Wisconsin. And though early saving is best, Rytilahti says families should act on any opportunity to save, regardless of the timeframe.
“It’s never too late to start,” she says. “Even if you didn’t start when the child was born, even if they’re in their teens, any thing you can get into an account to start earning money and possibly get a tax deduction will help.”