I consider education to be one of the most important investments that a person can make. Unfortunately, education costs have grown exponentially, with tuition prices jumping 178% since 2000. With this pace of education inflation, it is not surprising that many families view student loans as the only way to get their child across the graduation stage with a diploma in their hand.
While loans are a necessity for some, saving ahead for these costs can set your student up for success beyond graduation. Student loan carriers are more likely to have low credit scores. When combined with the strain of debt, this makes it more difficult for those with loans to purchase homes, start businesses, and it can affect their overall long-term financial stability. Saving specifically for education also eases some of the stress you may feel when the first-semester bill arrives, since you have a plan to tackle it.
Account Choices for Education Savings
There are quite a few account types that are commonly used for education savings in Washington, two of which we will explore today.
529 Education Savings Account
A 529 education savings account is the most popular account for education planning. A 529 is a savings account, usually owned by parents or grandparents. You can use the account on K-12 education, postsecondary education, and even apprenticeships. These accounts are typically invested in target date funds, where the investment mix becomes more conservative as the student’s college start date approaches.
The major advantage of 529 accounts is that the withdrawals are tax free when used on qualified education expenses such as tuition, room and board, and other qualified educational fees and expenses. The withdrawal amount is limited to $10,000 annually for K-12 expenses, but no limits exist for postsecondary expenses.
There are no annual contribution limits for a 529. However, contributions are considered gifts according to the IRS, so any contributions over $17,000 per donor per year are counted against their lifetime gift and estate tax exemption. Any individual can also choose to contribute up to five years’ worth of gift-tax-exempt contributions ($85,000 for 2023) in a single year to “superfund” the account without reducing their lifetime gift tax exemption.
The monetary value of a 529 account will impact the FAFSA calculation of the Expected Family Contribution because it is considered a parental asset if the account is owned by the parent. If the account is owned by a grandparent or someone else, it is not considered in this calculation.
If funds remain in the account and the beneficiary has finished school or decided not to pursue a postsecondary education at all, you can change the account beneficiary to a qualifying relative like a sibling or first cousin. You can do this up to once per year for unlimited number of years, so this is an efficient way to fund many generations of education for your family. The remaining funds can also be utilized to pay off up to $10,000 in student loans for the beneficiary or a sibling.
Starting in 2024, you can transfer up to $35,000 penalty- and tax-free out of the 529 and into a Roth IRA in the beneficiary’s name if the account is at least 15 years old. This is a great opportunity for excess 529 funds to be repurposed in a tax-efficient way and to give the beneficiary a significant start on their retirement savings. If the assets are used on non-qualified expenses or cashed out, the earnings are subject to income taxes and a 10% penalty on the earnings for either the owner or the beneficiary, depending on who made the withdrawal.
Washington State GET Program
The Washington Guaranteed Education Tuition (GET) program is a state-backed 529 prepaid tuition program. The program allows anyone to buy GET units on behalf of a student that is a Washington resident to lock in today’s tuition price. This is an excellent way to guarantee your child’s college tuition will be taken care of regardless of the increase in education costs. This allows you to avoid the market volatility and risk in a standard 529 savings account.
GET guarantees that if you purchase 100 units today, those 100 units will cover the cost of one year of undergraduate tuition and fees at any Washington public university whenever the student begins school. More units may be needed to cover tuition at more expensive schools like certain private schools, and fewer may be required for some schools like community colleges. You may purchase up to 800 units total per student and use up to 200 units per academic year.
Like a 529 savings account, GET withdrawals are tax free when used for qualified higher education expenses. They can be used at almost any public or private college, university, or technical school in the U.S. and even some universities in other countries. GET units cannot be used on K-12 expenses.
For the 2022-23 period, each GET unit costs $116.63. Donors can purchase partial units or up to 800 units at once. All contributors are still subject to the gift tax laws and any donation over $17,000 per donor per year will affect their gift and estate tax exemption.
A GET account is a type of 529 account, so it is considered an asset of the account owner and will affect the Expected Family Contribution amount determined by the FAFSA if the account owner is the parent.
The beneficiary has ten years to use all the GET units from the time of their initial withdrawal. If your student does not use any or all units, you can elect to change the account beneficiary to an eligible family member. The account can also get rolled into a standard 529 savings plan in the original beneficiary’s name or transferred to a family member.
The same taxes and penalties imposed on 529 savings accounts are in place if you request a refund and withdrawal from the GET program for non-qualified expenses.
A few other commonly used accounts for education savings are a UTMA or UGMA, Coverdell ESA, Roth IRA, or standard brokerage or savings account. Each of these account types also comes with its own set of advantages and drawbacks, so it is important to consult with your accountant and financial advisor to determine the right account or account mix for your family.
Strategies for Saving
After deciding what savings path is best for your student, you need to set realistic savings goals based on what level of financial support you want to provide them with and what you can afford. If you make saving a habit, it is easier to stay on track, so consider setting up monthly automatic withdrawals from your bank account into the education account.
Some parents get creative and ask relatives to donate to their young child’s education account for birthdays and other holidays in lieu of gifts. That can work well until your child is old enough to realize they are missing out on some good loot!
Encouraging your student to contribute some of their earnings to the account is another way to bolster the account balance. This serves a dual purpose by allowing them to experience what it is like to save towards long-term goals and can help them adopt a healthy relationship with money.
The cost of tuition is continuing to rise, and the earlier you start saving, the more time you allow for the account to grow through compounding returns. Today is the best day to start. If you have questions about educational savings opportunities, contact an HFG Trust Advisor today.