By Jim Terwilliger
Believe it or not, students and their families are looking at $250K to $300K to fund four years of higher education for one person at a private college in the northeast.
Sure, there are ways to reduce total out-of-pocket costs to a significantly lower amount for a four-year degree. But even that is still a lot of money.
Enter Grandma and Grandpa.
The most cost-effective, flexible, tax-advantaged method I know and recommend to clients for college savings is the federal 529 College Savings Program. In New York, we have an excellent plan — the New York State Direct College Savings Program. Annual administrative costs are low (0.15 percent) and investment choices consist of a series of solid, low-cost Vanguard index mutual funds.
529 Plan Basics. These plans are tax-free, much like Roth IRAs. Contributions are made from federal after-tax dollars — and distributions (principal and earnings) are entirely tax-free if they are “qualifying.” That is, in a distribution year, distributions must not exceed the total of qualifying out-of-pocket higher education expenses for that student that year including tuition, room/board, books, supplies, fees and computers.
In New York, it gets even better. Annual contributions up to a total of $5,000 single and $10,000 married-filing-jointly can be deducted from NYS taxable income.
If a distribution is not “qualifying,” there are negative consequences. First, the earnings portion of any non-qualifying distribution is taxed at both the federal and state levels. Second, there is a 10 percent federal tax penalty on the earnings portion of the distribution. Finally, there is recapture of any previous NYS income tax deductions related to the original contribution.
Each 529 savings account can have only one owner (usually the parent or grandparent) and one beneficiary (the student). Although not common, the owner and beneficiary can be the same person.
Contributions to a 529 plan remove the assets from the donor’s estate, but the donor/owner retains complete control of the gift, not the beneficiary. If necessary, contributions can be reclaimed by the donor via a non-qualifying distribution. Also, the account can be redirected without penalty to another family-member beneficiary, including the beneficiary’s children or even back to the donor.
Financial Aid. Assets in a 529 account owned by a parent, either directly or as a UGMA/UTMA custodian, is considered a parental asset when the annual Free Application for Federal Student Aid (FAFSA) form is completed for the student. As such, 5.65 percent of the account balance is considered available for the family contribution in the next school year.
Grandparent- and non-parent- owned plans get special treatment. Such 529 plan funds are not reportable as assets on the FAFSA form. However, when distributions are ultimately made, such annual distributions are counted as untaxed student income, and 50 percent is considered available as a family contribution the following year.
Good News. Due to a 2016 timing change, there is now an extra year delay between the tax year and filing of a FAFSA form. For example, FAFSA forms filed in the fall of 2018 will be based on 2017 tax year. So, a distribution taken by a grandparent in 2017 will not impact a grandchild’s financial aid until the 2019-2020 school year.
Net result. Distributions by grandparents for qualifying expenses taken as early as second semester sophomore year will not be counted negatively for financial aid purposes through the fourth college year. Previously, grandparents needed to wait until second semester of the junior year to take distributions in order to avoid impacting financial aid negatively.
Not-So-Good News. The recent federal tax law expanded the scope of qualifying education costs to include tuition for K-12 grades. The bad news here is New York state’s current position is that while K-12 tuition expenses are qualifying for federal income tax purposes, they are not qualifying costs under New York statutes.
This means that distributions for K-12 tuition would not be free of taxation for the earnings portion on the New York income tax return. Further, any earlier associated NYS contribution-related deductions would be recaptured. Not a pretty picture. We may see further rulings from the state, but until we do, it is best to stay away from the K-12 option.
Lots More. The above is just a quick snapshot of the 529 program and how grandparents can make use of it. Check out the NY Direct Plan website at www.nysaves.org. The site is full of information and can be used to open and fund accounts conveniently. But, as I always advise, don’t try this on your own. Work with your financial planner to learn more about the program and to develop a workable college savings strategy.
James Terwilliger, CFP®, is a senior vice president and senior planning adviser with CNB Wealth Management, Canandaigua National Bank & Trust Company. He can be reached at 585-419-0670 ext. 50630 or by email at firstname.lastname@example.org.