How Savvy Investors Plan for Education Expenses

There is a changing reality for many parents – advanced planning and a long-term strategy for financing a child’s education are becoming more of a necessity than a luxury, even for families of significant means. Education funding is one of the largest expenditures most American families will undertake, and costs continue to grow.

Funding four years of college, or potentially more, requires forethought, and savvy families need to consider how they will pay for post-secondary education, potentially including both college and graduate school. The best chance we see for a successfully executed savings plan includes getting started well in advance and harmoniously incorporating the right mix of strategies. Some families can reap significant tax and estate planning benefits. The nuances can be complex, but many families can employ opportunities for generational wealth transfer.

Getting Started: Common Types of Education Savings Accounts

Setting up college savings accounts to benefit a child can be done in several ways, the most common being 529 savings plans. Named for Internal Revenue Service Code 26 U.S.C. § 529, these tuition plans are sponsored by states or educational institutions. Custodial accounts, or Uniform Transfers to Minors Act (UTMA) accounts, are also common and offer different benefits.

529 Plans

Anyone can open a 529 plan — a parent, grandparent, guardian, aunt, uncle, neighbor, or friend — but in some states, the account owner may not be entitled to the full tax benefits unless the beneficiary is a dependent. Whoever opens the 529 account is the owner and remains in control of the funds even after a beneficiary reaches the age of majority. The major benefit of a 529 plan is that growth on investments is tax-free, with most states offering additional benefits in their plans (such as in-state tax deductions). An owner can also change beneficiaries to another family member of the beneficiary (or even themselves when related to the beneficiary). Funds held in a 529 account may be withdrawn and used for qualified post-secondary education expenses and K-12 expenses (with limitations), otherwise taxes and penalties may be incurred. It is important to note that, when registered in a parent’s name, 529 plan assets are considered parental assets from a FAFSA (Free Application for Federal Student Aid) perspective.


The total amount contributed to a 529 plan for each beneficiary is defined by the plan and each state has a set cap. In addition to the total allowable contribution, most states allow for limited state tax benefits. Some states may allow a state tax deduction for contributions to another state’s plan, while others may only provide the deduction for specific plans.

Should a family decide to move to another state, many states will allow them to “rollover” the account to the new state plan. This can present a huge tax benefit for families when states allow it; however, the prior state may seek to recapture the state tax deduction.

As mentioned above, the Tax Cuts and Jobs Act, passed in late 2017, includes a provision allowing families to use 529 plans for up to $10,000 of K-12 expenses. It is important to understand how each state handles these types of withdrawals to ensure that distributions for these purposes don’t cause adverse outcomes (such as a recapture of previous state tax deductions). Families considering using 529 plans for primary or secondary school should also reconsider the time horizon and investment profile of their 529 accounts. Furthermore, some states will allow for other more tax advantageous ways to cover these expenses.

Use Education Gifting as an Estate Planning Strategy

In addition to the future benefits created by education savings, a family’s savings efforts can also aid in reducing a taxable estate. While 529 contributions are subject to the annual gift exemption (currently $18,000/$36,000 for couples in 2024), gifts can be “front loaded”, or given all at once to meet a maximum over multiple years. For example, a one-time gift of $90,000 would cover five years of maximum contributions, but the additional compounding interest in that account would not be subject to a gift tax.

There is one caveat – contributions to a 529 plan above the annual gift tax exclusion are allowed and it will be averaged over five years. For example, for a gift of $40,000 in 2023, the gift will count towards $8,000/year of the gift exclusion over five years, not two. There would be room for other gifts toward the exemption in the intervening years; however, it is important to be cognizant of what happens if you exceed the annual gift limit. Excess gift amounts will then count against your lifetime limit, and if that is exceeded, be subject to taxes.

College tuition paid directly to the institution is also not considered a gift and therefore would not use up annual exclusion gifting. An affluent individual looking to avoid gifting limitations like those mentioned above could simultaneously pay tuition expenses directly to the institution and gift to a 529 plan at the maximum rate. This combination of strategies is most helpful to those looking to reduce their estate by more than the amount subject to the gift tax and can reduce the need for the 529 funds on the part of the named beneficiary. This way, the money contributed to a 529 account can grow tax-deferred and be passed on to later beneficiaries, even those in the next generation.

Consider this example: A grandparent could set up ten 529 accounts, one for each of their 10 grandchildren, and max out the $90,000 gift limit for each. This allows for possible (tax-free) growth on $900,000 outside of the grandparent’s estate. However, if one of the beneficiaries decided not to continue post-secondary education and the grandparent seeks to change the beneficiary, the possibility of triggering a “generation skipping tax” needs to be considered.

The mechanics of the “front loading” of gifts to a 529 plan can get complicated if the grandparent or grantee passes away. For example, if a grandparent gives the full $90,000 to a grandchild and passes away three years later, the first three years fall under the gift exemption, but the remaining amount in years four and five is added back into the grandparent’s estate. There still remains a tax benefit, though, as the growth of those funds occurs outside the estate.

Taxes, Additional Tax Credits, Exemptions, and Deductions

The tax deductibility of 529 plans differs by state. Some states allow a deduction only for contributions to the in-state plan. Others will allow a deduction for contributions to any plan. Some states offer no state tax benefit. For all 529 plans, gains on investments in the plan are federally tax-free when withdrawn and used for qualified education expenses. Funds withdrawn from 529 plans and not used for qualified expenses can face taxes on gains, penalties, and in some states, recapture of any tax deductions taken.

In addition to 529s, there may also be tax credits for families paying for education:

  • The American Opportunity Tax Credit is available for four years of post-secondary education. It is a credit of $2,500 (100% on the first $2,000 of qualified expenses, and 25% on the next $2,000). If the credit brings the tax owed down to zero, a family can get a refund of up to $1,000 of the remaining credit. However, there is a phase-out for families with (modified) adjusted gross income of $160,000 to $180,000, and those earning more than $180,000 are not eligible. In addition, actual education expenses must be paid by the family; a student with a full scholarship or one who has all of the expenses reimbursed by a 529 cannot take advantage of this credit.
  • The Lifetime Learning Credit is a credit of 20% of qualified education expenses up to $10,000 per year for the taxpayer, the spouse, or a child. This is only available for individuals with individual income below $90,000/$180,000 for a couple (with a phase-out starting at $80,000/$160,000) and needs to be thoughtfully coordinated with the American Opportunity Tax Credit. Each beneficiary is allowed to take one credit or the other, but not both.

Most wealthy investors assume they are not eligible for certain education-related tax credits or deductions. However, that may not be the case based on individual circumstances. A first step is to consider the tax situation of each family member, as well as that of any potential contributors.

Adjusted Gross Income (AGI), taxable income, and the state of residence will impact the credits, exemptions, and deductions available when paying for education. While a parent may not be eligible for an education tax credit due to the parent’s AGI, his or her child might be able to take the credit. For example, one of our clients has a daughter who had recently graduated and was working full-time and completing her first tax return. Because the client’s daughter was providing her own support, she realized she was eligible for the American Opportunity Tax Credit for tuition paid in her final semester of college. By integrating the daughter’s situation with that of the parent, the family saved $2,500 in taxes. It is important to note that these education expenses, if used to claim a tax credit, cannot be reimbursed through 529 funds.

Additionally, for those in a position to affect final AGI, families might find it advantageous to do so. Pay particular attention to AGI for families facing variable income. Focus on lowering AGI through strategies such as 401(k) contributions.

Use of Funds for Education

It is important to know the rules on what types of expenses are eligible under 529 plans and when those funds are available for withdrawal to avoid penalty. Using funds for anything other than qualified education expenses can cause tax, penalty, and a recapture of the state tax deduction. Tuition, room, and board are the obvious eligible expenses. A full list of qualified education expenses can be found here. Note that different expenses are considered qualified for 529 use and eligibility for the various tax credits. Also, some states might have definitions slightly different than the Federal definitions.

Withdrawals must only be taken from the account for the beneficiary who incurred the education expense. Taking from another’s account, say a sibling, will subject the funds to the above-mentioned penalty and taxes. One other thing to keep in mind should a grandparent set up the 529 account is that funds in a 529 account are owned by the account owner; a beneficiary cannot call up and take funds out of the account.

Distributions generally happen in three ways – the money can be paid to the educational institution, paid directly to the beneficiary, or paid to the account owner. There are arguments on all sides about how best to distribute funds. As you make the decision regarding the process that is right for you, it is important to keep in mind a few items. One, if the funds are sent to an individual rather than the school, a 1099-Q will be generated for tax reporting purposes. Two, the timing of the distribution relative to incurring the expense is important. Crossing calendar years can cause difficulties in matching up qualified expenses with withdrawals and may even result in penalties and taxes.

Many education expenses for different types of higher education institutions are eligible; however, some are subject to limits. For example, someone living in off-campus housing might still be able to use 529 funds for some of the expenses, but these costs are limited to the housing expenses delineated by the college’s financial aid department.

Both the timing and the amount of withdrawals are important, as they can impact financial aid and education credit eligibility. Generally, withdrawals should be taken in the same calendar year as the expense occurred.

What If There Are Excess Funds in a 529?

When there are unused funds in a 529 account after the beneficiary has completed college, one sound strategy is to change the beneficiary and/or account owner. For example, the new beneficiary could be a younger sibling who has yet to complete college, or an older sibling with remaining graduate school expenses. A theoretical example of a new account owner could be an adult child assuming ownership to jump start the education funding for a current or future grandchild. It is important to be aware that a change of beneficiary or owner can be considered a gift for gift tax purposes. Advisors and accountants should ensure the process is handled correctly.

Money can remain in a 529 account even after the beneficiary completes college with no consequences. In fact, it can be a smart move to keep the funds in the account in case the beneficiary later decides to return to school. If the money is likely to stay in the account for a while, it may make sense to reconsider the risk profile for the funds. There are also provisions to allow for a distribution of up to $10,000 to pay down qualifying student loans.

Finally, SECURE Act 2.0 added a new option allowing the rollover of 529 funds to Roth IRAs, starting in 2024.  There are a number of restrictions associated with this strategy, and some clarity is still needed, so it would be wise to seek out proper counsel before acting.

It is important to note that states might have slightly different rules when it comes to qualified expenses or treatment of different account activities. As such, when considering any strategies for excess funds, it is important that you also understand the specific state provisions that apply to your situation.

For more information on SECURE Act 2.0, please view a published article found here by our Financial Planning Committee.


Thoughtful education planning can incorporate a combination of strategies, such as those mentioned here, and can ultimately establish education funding for multiple generations within a family. Successful strategies can also provide gifting and estate planning opportunities for parents and grandparents. Working with your financial advisor, attorney, and accountant is the best way to structure a successful education planning strategy that works best given your personal financial situation.




Wealthspire Advisors is the common brand and trade name used by Wealthspire Advisors LLC, Private Ocean, LLC, and ACG Advisory Services, LLC, separately registered investment advisers and subsidiary companies of NFP Corp.
This information should not be construed as a recommendation, offer to sell, or solicitation of an offer to buy a particular security or investment strategy. The commentary provided is for informational purposes only and should not be relied upon for accounting, legal, or tax advice. While the information is deemed reliable, Wealthspire Advisors cannot guarantee its accuracy, completeness, or suitability for any purpose, and makes no warranties with regard to the results to be obtained from its use.
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© 2024 Wealthspire Advisors
Razi Hecht

About Razi Hecht, CFP®

Razi is a wealth advisor in our Delafield, Wisconsin office.

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