Paying for College

Proactive planning can help reduce the financial burden of funding college expenses.
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Paying for college can be a daunting prospect. Tuition, room, board, and mandatory fees at top four-year private universities are north of $60,000 per year, and continue to climb. Even in-state costs at public universities exceed $24,000 per year. None of these costs include travel and incidental expenses. Needless to say, a college education is an investment. But what are the best ways to pay for college? What should be done to save for college? How do accumulated savings affect potential financial aid awards?

Saving for College: UTMA Accounts, 529 Plans, and Irrevocable Trusts

Although this is not an exhaustive list, three popular vehicles used to save for college expenses include Uniform Transfers to Minors Act (“UTMA”) accounts, 529 Plans, and irrevocable trusts. All are funded with irrevocable gifts, including annual exclusion gifts, but each has its own benefits and limitations.

UTMA Accounts: An UTMA account is easy to establish, can be invested however the adult custodian determines, and can be used for almost anything that benefits the child other than traditional support obligations. The flexibility and simplicity of UTMA accounts make them attractive. Their significant limitation is that children gain control of any assets remaining in the account when they reach a given age. In most states, this occurs at age 21, although it can be as young as 18. It is easy to see how an UTMA account could be funded with $100,000 or more by the time a child reaches age 21, and although adults realize that this is not a lot of money, it can certainly sound like it to a child who may have only had summer jobs up to that point. In addition, under the Kiddie Tax, the earnings beyond a small threshold from a child’s UTMA account are taxed at the parents’ marginal federal tax rate. Another potentially significant concern with UTMA accounts is that they are considered the child’s assets for financial aid calculation purposes, which means that the Expected Family Contribution (“EFC”) will include a higher percentage of this asset than many other assets.

Section 529 Plans: Section 529 Plans, also referred to as Qualified Tuition Plans, were established by Congress in 1996 under IRS code section 529. The most attractive feature of 529 Plans is tax-free growth, which is available as long as the assets are used for qualified education expenses. Qualified education expenses include tuition, room, board, fees, books, and even some technology-related expenses for the named beneficiaries while they are enrolled at an eligible educational institution on at least a half-time basis. Eligible education institutions include colleges, universities, vocational schools, and other postsecondary educational institutions that are eligible to participate in U.S. Department of Education student aid programs. Graduate schools and even some institutions located outside of the U.S. can also qualify. Begining in 2018, 529 Plans were expanded to include up to $10,000 of tuition expenses at an elementary or secondary public, private or religious school.

There are two main types of 529 Plans. The most common is the college savings plan but in almost all cases a 529 Plan allows the funds to be used at any qualified postsecondary educational institution. A less common type is the prepaid tuition plan, which can require that the funds be used at a limited number of qualified postsecondary educational institutions. It is important to understand the type of plan being funded and any limitations it may have. Different plans will have different maximum funding limits, with current limits for some plans over $450,000. Amounts not needed for a beneficiary’s education can be transferred to a 529 Plan for certain other relatives or their spouses, including, but not limited to, siblings, nieces, and nephews, without any negative tax consequences. First cousins are also eligible beneficiaries. If the assets are withdrawn and used for other than qualified education expenses, the earnings will be subject to income tax, and may be subject to a 10% penalty.

Although the 529 Plan donor does not receive a federal income tax deduction for the gift, it can qualify as an annual exclusion gift. In fact, the donor can elect to make an upfront gift of up to five years of annual exclusion gifts to a 529 Plan, which translates into a current gift of up to $70,000 per donor for each beneficiary. It should be noted that under this circumstance, the donor cannot make additional annual exclusion gifts to that beneficiary during the five-year period. There is no requirement that the beneficiary be a relative, and in fact donors can even establish 529 plans for themselves. The account owner is often the person making the gift to the 529 Plan, but a person can make a gift to a 529 Plan that someone else has established for a given beneficiary. The person who establishes the plan is considered the owner and therefore makes the investment and distribution decisions relating to the plan’s assets. For financial aid purposes, a 529 Plan with a parent owner is counted as a parental asset, and therefore under the Free Application for Federal Student Aid (“FAFSA”) system is counted as a 5.64% asset and plan distributions are not counted as income. Another approach is to have the plan owned by a grandparent, which is then excluded from the asset test calculations, but distributions from the plan are then considered income for FAFSA purposes (but not necessarily for federal income tax purposes). If a family is trying to maximize financial aid by having a grandparent own the 529 Plan, it is most beneficial to not utilize the 529 Plan assets to pay college expenses until close to the beneficiary’s senior year of college so that any deemed income distributions for financial aid purposes do not impact subsequent financial aid awards. A given beneficiary can have more than one 529 Plan. In order to maximize financial aid, it may be advisable to have a parent be the owner for one plan and a grandparent the owner for a second plan.

Two of the key questions to ask when selecting a 529 Plan include which state’s plan should be utilized and who should be the account owner. All states have one or more versions of a 529 Plan, and it is not necessary to utilize your state’s 529 Plan, although you may wish to if your state provides tax benefits to their residents related to their 529 Plan. Beyond that, a donor should look at both the investment choices that are available for a given 529 Plan as well as the investment and other management fees that are charged by the plan administrator. Investment choices and fees vary widely. Some plans invest the assets solely based on a beneficiary’s age, while others provide investment choices within a range of asset classes. No plan can allow complete discretion in investment choices. Before finalizing a choice, it is advisable to review the terms and limitations the particular plan has, including the ability to change beneficiaries or roll the assets into another 529 Plan, and any limits on the age of plan beneficiaries or how many years they are eligible to receive distributions from the plan.

One of the key drawbacks of 529 Plans is that in order to maximize the income tax benefits and avoid any potential penalties, their use is limited to qualified education expenses. As such, it is advisable to not overfund 529 Plans. In fact, if the goal is to maintain spending flexibility, an irrevocable trust may be a better vehicle choice.

Irrevocable Trusts: When a family has significant wealth, an irrevocable trust is a better savings and wealth transfer vehicle than either a 529 Plan or an UTMA account. Irrevocable trusts can be drafted with flexibility to benefit one or more beneficiaries, with distributions being allowed for almost any reasonable purpose and not limited to higher education expenses. There are no maximum funding amounts with irrevocable trusts, and investment choices are completely flexible. One drawback is that income is taxable, often at a high rate. Therefore, it may be best to invest for capital appreciation in order to minimize the tax impact. If a family has enough wealth that tuition can be paid by parents or grandparents, then the flexibility of the irrevocable trust becomes even more attractive because the funds can be used for other life goals. The irrevocable trust can continue to be funded with annual exclusion gifts while tuition can, in addition, be paid directly to the educational institution by the parent or grandparent because it does not count as a gift.

Paying for College: Is Financial Aid Available?

When there is a gap between savings and the cost of a college education, it may be time to explore available financial aid. Financial aid from colleges and universities can be broken down into two broad categories: merit-based and needs-based. Outside scholarships and loans may or may not be included in either of these categories.

Merit Aid: Merit aid is money given because of some attribute that the college or university recognizes in the student – such as academic, athletic, musical, or artistic ability. Many schools will give merit aid regardless of calculated financial need, but may still require a family to fill out financial aid forms in order to be eligible. Merit aid does not need to be paid back and may or may not be renewable.

Needs-Based Aid: Most financial aid granted is needs-based, with the majority of institutions relying on the
completion of the FAFSA to begin the process. In fact, in its pure
form the FAFSA is known as the “federal methodology” and schools use this method to allocate federal aid. Schools can, by their choice, allocate their own financial aid under their own “institutional methodology,” with about 300 schools utilizing the College Scholarship Service Profile (“CSS Profile”) and another two dozen using what is known as the Consensus to determine need. Many schools will also have their own forms and questions that help them tailor the amount of the EFC. It is important to understand what a particular school’s process is because different family circumstances may result in significantly different amounts of aid under the varying approaches. Although this discussion will focus on the FAFSA, the intent of any of these methods is to determine the EFC, which is the maximum total amount a family should be expected to contribute to education costs, regardless of how many children are in college at the same time. Elite schools publicize that they will meet 100% of the EFC, while schools with lesser endowments may not be able to do so. This can translate into a family being asked to contribute even more than their EFC. In addition, some schools rely more heavily on loans than “free” aid to meet the EFC. It is important to review any financial aid award letters and understand the details in order to have a better idea of the real cost of the school. It is also important to understand how a particular school treats outside scholarships, because some schools actually use them to reduce the school’s aid package. Even before applying, a family can utilize the “net price calculator” that each institution is required to have on their website to get an idea of how the school approaches the financial aid calculation. Sometimes the best way to locate these seemingly hidden calculators is by searching for “net price calculator” within the school’s website.

Generally speaking, the calculation looks at a family’s income and assets and tries to determine what the family should be able to contribute to the cost of education. What the school determines to be reasonable and what a family views as reasonable may vary widely. Within the calculation, there is a modest amount set aside from income for relatively minimal living expenses and then a small asset safe harbor. In addition, amounts in retirement accounts are disregarded, although amounts used to fund retirement accounts and health savings accounts are added back to income. Since income taxes paid are deducted from income, by choosing to fund a Roth 401(k) account instead of a standard 401(k), a family may pay more current income taxes while ultimately increasing their financial aid award. After allowances, on the income side, FAFSA schools will expect a family to contribute up to 47% of the parents’ income and up to 50% of the student’s income. The EFC will include a lower amount of family assets, with parents’ assets requiring a maximum 5.64% annual contribution and the student’s assets a 20% contribution. The FAFSA excludes the value of the family home, family farm, and 529 Plans not controlled by the parent or student from available assets. In addition, the FAFSA gives a break to divorced parents where the low-income parent has= primary custody. For CSS Profile Schools, home equity and non-custodial parental income and assets will inpact the EFC calculation. Regardless of whether a family is required to complete the FAFSA or CSS Profile, questions should be reviewed carefully to determine the proper disclosures. An irrevocable trust or its distributions may be included in either the asset or income calculation depending on the terms of the trust and the circumstances. Gifts received by parents or the students generally also require disclosure. All of this taken together makes it apparent that parents should fund their retirement before they save for college, and should be careful about putting too much money in a child’s name if they plan to apply for financial aid.

The Bottom Line

The bottom line is that a college education is a significant financial commitment. Who will ultimately pay for the education, and whether any meaningful form of financial aid will be available, will vary greatly depending on the family’s circumstances. As with so many things in life, the best course of action is to understand the dynamics and
plan ahead.


  • Jody R. King, JD, CPADirector of Wealth Planning
    As the leader of Fiduciary Trust Company’s wealth planning practice, Jody focuses on developing customized wealth plans for clients that integrate all aspects of estate and finan...

The opinions expressed in this publication are as of the date issued and subject to change at any time. Nothing contained herein is intended to constitute legal, tax or accounting advice and clients should discuss any proposed arrangement or transaction with their legal or tax advisors.

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