MK – Intro: Hello, everyone, and welcome to this week’s episode of From the Desk Of, our podcast about markets, life, and things financial. My name is Mary Katherine Glassman, and I’m joined by my colleague Cassidy Murphy. We are both Financial Planners with FinTrust Capital Advisors.
MK: With summer winding down and back-to-school season in full swing, we thought that this would be a great opportunity to discuss education planning and answer some of the most common questions that we receive from our clients.
Cassidy: Yes, and let me start out by saying that as a mom of three myself, saving for college is a topic that I’ve put a lot of thought into. Now we all have different opinions on how much of our children’s educations we want to pay for, how comfortable we are with our kids or ourselves taking on student loans, and even what college education might look like down the road. Whether we think our kids will end up at a traditional university, if it’s public or private, a community college, a trade school? The landscape is constantly changing. One thing we do know, though, is that the cost of education continues to rise, and studies have shown that about 54% of education funding ends up coming from the parents, so it’s always good to be prepared and plan ahead.
MK: Yes, exactly. And with that in mind, today, we are going to focus on the two most widely used types of accounts which are 529s and UTMAs. Cassidy, I feel like people are probably less familiar with a UTMA, so can you tell us a little bit about those accounts and how they work?
Cassidy: Yes, so UTMA stands for a Uniformed Transfers to Minors Act account. Or, in some states, it’s called a UGMA, or Uniformed Gift to Minors. Now, these accounts aren’t specifically designed for college savings, but they are designed as a means to set aside money to grow for the benefit of a minor. The most important thing to remember about UTMAs are that anything you put into the account is considered an irrevocable gift, so there are no take-backs, and withdrawals have to be used for the benefit of that minor. Now whether that’s buying them a car, new clothes, paying their rent, it can be used for pretty much any expense as long as it’s for the beneficiary, so you have more flexibility in that respect. But there also aren’t the any tax advantages. One major potential drawback is that at the age of majority, which in most states is 21, the UTMA account terminates, and any remaining assets become the beneficiaries outright. So, if you plan on funding the account with more money than you would eventually trust to a 21-year-old, just keep that in mind. UTMA assets also have a significant impact on financial aid packages since they are considered assets of the student.
MK: Those are some really great things to be aware of; thanks for sharing. In terms of saving specifically for college expenses, then, I know most people have probably heard of 529 accounts. So, tell us what’s so special about those.
Cassidy: So 529s work much differently in that their sole purpose is education savings. Now, unlike with a UTMA, where the assets technically belong to the minor the entire time, 529 funds always belong to the account owner, and the owner can change the beneficiary at any time, as long as the new beneficiary is related to the old one. So, if you start a 529 for your oldest child and they don’t end up needing all of the money, you can change the beneficiary altogether. Or you can just roll over a portion of it, and that can go to a younger sibling, a cousin, their spouse, even yourself. There is also no age where the 529 has to be terminated, and there actually are some pretty great tax benefits both when you fund a 529 and when you eventually withdraw the money to pay for college expenses.
MK: That’s right, so a unique thing about 529 plans is that they’re sponsored by individual states, and while there’s no federal tax deduction for contributions, many states offer a deduction for state tax purposes. For South Carolina residents, for example, contributions are fully deductible. And in Georgia, you can deduct up to $8,000 per beneficiary for married couples. This applies to anyone who contributes, so grandparents can benefit from these tax advantages as well. Where it gets even better, these contributions to the 529 accounts grow tax deferred and can be withdrawn tax-free when used for qualified education expenses, which could be college tuition and fees, books, supplies, room and board, and even $10,000 per year towards K-12 private school tuition.
Cassidy: Yes, there are so many more tax benefits with a 529 plan if your goal is just saving for college. I think we’ve hit most of the highlights here, but I did want to point out a couple of other things that we get asked about a lot. Now, one common concern that I hear is, “What happens to funds in a 529 if my kid doesn’t end up going to college, or what if they get a scholarship instead?” In the latter case, if they receive a scholarship, you can still withdraw funds from the 529, and they’re still tax-free, up to the amount of the scholarship for each year. On the other hand, if they don’t end up going to college or they otherwise just aren’t able to use up all of the money, the best course of action is usually to roll the balance over to another beneficiary because that lets you observe the tax deferral. Now you can still withdraw funds for non-education expenses at any time, but you’ll have to pay ordinary income tax and a 10% penalty on any of the earnings.
MK: That’s definitely a question that comes up a lot. Another one that we get is, “How much can I contribute, or how much should I contribute?” Technically, there is no limit on how much you can contribute each year, although most states cut off contributions once an account balance reaches somewhere around $500,000 or so. A lot of people may have heard a figure of $16,000 thrown around, and that is the annual gift tax exclusion amount each year. Many people choose to contribute that amount because anything higher would need to be reported to the IRS as a gift and would count against your lifetime exclusion. However, 529s also allow for an owner to superfund an account by contributing five years’ worth of gifting at once. So, for 2022, that’s $80,000 per donor per beneficiary without having to report any sort of gift. Of course, not everyone needs to fund that much or can afford to fund that much. So, we always run customized calculations for our clients based on their unique goals and savings capacity.
Cassidy: That’s a great point as well. When it comes to getting started with college savings, I think it’s really important to remember that even if you can’t set aside a significant amount up front, starting with small monthly amounts can still be very beneficial. The key is to create a plan, stay the course, and make it a habit. But like with most long-term savings goals, starting early is also important to leverage the power of compounding.
MK: For sure.
MK – Closing: Well, I feel like we have covered a lot of great information today and that our listeners found it helpful. It is impossible to cover everything in just a few minutes when there are plenty of things to consider and even different types of accounts that we didn’t get to discuss. So, if you have any questions about anything we have talked about or what the best advice would be for your unique financial situation, please reach out. Thank you all for listening.
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