By Josie Parkhurst, Staff Accountant, Falco Sult
If you have young children, the cost of college education may not yet be at the top of your priority list, especially with all the other expenses parents face daily. Based on a 2017 analysis, the cost of childcare alone currently exceeds that of college tuition in 28 US States. However, in the current economic climate, planning for your child’s education may prove to be essential.
The average cost of tuition in the US at a public, 4-year University rose 34% between 2006 and 2016, to an average of $19,189 per year in 2016, adjusted for inflation. If the current trend continues, college education costs will rise around 6% per year, resulting in an annual cost of $54,000 for public college and $120,000 for private, by 2035. Considering these trends, it may be necessary for parents to begin saving for college as early as possible.
There are a few options available to save for college, many of which include tax incentives, such as Coverdell Savings Accounts and 529 Qualified Tuition Plans (QTP). Both plans must be held in a qualified trust for benefit of a designated beneficiary and both are funded with after tax cash contributions. All contributions are considered completed gifts and distributions from both Coverdell and 529 Plans are non-taxable to the beneficiary to the extent that they “do not exceed the adjusted qualified education expenses incurred by the beneficiary during the year.” Qualified expenses incurred may also include costs for primary and secondary school. Excess distributions may be subject to ordinary income tax and a 10% penalty. There are various limits on annual contributions, and different investment options, explained below.
Coverdell Savings Accounts are self-directed investment accounts allowed to grow in a trust. The limit on annual contributions is $2,000 for each beneficiary until they turn 18, unless special needs apply. The ability to contribute to a Coverdell account may be phased out if the contributor’s modified adjusted gross income exceeds a threshold amount (Buchanan J. J., 2019).
529 Qualified Tuition Plans are established and maintained at the state level or by an eligible education institution. Contributions may not exceed the amount “necessary for the qualified education expenses of the beneficiary” and there is also no income limit for contributions.
Washington State has established two 529 savings programs: GET Prepaid Tuition Program and Dream Ahead College Investment Plan.
With GET, taxpayers have the option of purchasing education “units” via the Washington GET Savings plan. Each block of 100 units represents a year of tuition at the highest priced state institution. This is a way for parents to hedge against rising tuition costs since the state guarantees these funds against tuition inflation.
The Dream Ahead program offers the same tax treatment as any 529 plan, with various investment options and more flexibility in terms of growth, as it functions more like a savings plan than a pre-paid plan like the GET Program.
Due to the various utility, benefits, and drawbacks of each type of plan, it may be beneficial to invest in multiple tax-favored vehicles at once when saving for education. Key things to keep in mind when creating your tax-favored college savings plan: understand the benefits and limitations, prioritize, and plan.
If you would like to learn more about education savings plans, please contact our office to schedule a meeting with a member of our tax staff.