The cost of an undergraduate education has skyrocketed over the past several decades. Specifically, over the last decade the increase in the cost of college has exceeded the increase in the cost of most goods by an average of 3.2% per year. The cost of college can vary based on whether a student attends an in-state public school, an out-of-state public school, or a private school. For example, based on the most recent tuition data published by colleges, the average annual tuition for a four-year program is $9,410 at an in-state public school, $23,890 at an out-of-state public school, and $32,410 at a private school, in addition to the cost of housing, food, books and supplies, etc.. Additional helpful information about the expected costs of education by state and type of institution can be found on the College Board website.
With education costs seemingly growing ever higher, it’s important for families to have an efficient way to save and leverage any amount they are able to set aside. Currently, all fifty states and the District of Columbia offer at least one type of 529 Plan, or Qualified Tuition Program, which provide tax-advantaged savings options for future education costs. There are two types of 529 Plans: Prepaid Tuition Plans and Education Savings Plans.
In order to help you make an informed decision regarding college education funding, we outline general information and the advantages and disadvantages of each of the funding vehicles are outlined below.
Educational Savings Plans
These are state sponsored investment accounts, which have a set menu of investment options.
| Advantages | Disadvantages |
| Tax-deferred growth and tax-free qualifying distributions | The investment options may be limited and may be changed only once or twice every twelve months |
| Contributions are income tax deductible in some states | The account is exposed to market volatility |
| High limits - most states’ contribution limits exceed $300,000 per beneficiary | Rollovers or changing the beneficiary may be subject to state and/or generation skipping transfer taxes, and can only occur once every 12 months |
| Contributions qualify for the annual gift tax exclusion (i.e., $15,000 in 2019) | Depending on the account owner’s state of residence, the assets may or may not be protected from creditors |
| Accelerated gifting allows individuals to contribute 5 years of gifts ($75,000 per beneficiary) in a single tax year | Non-qualified withdrawals are allowed, but earnings are taxed as ordinary income and incur a 10% penalty. Contributions may incur retroactive state income taxes |
| The assets are excluded from the donor’s gross estate | May include sales loads — as high as 5% or 6%. Investment fees may be as high as 2% |
| The account owner retains control & may change the beneficiary to a different qualified family member1 tax-free | |
| Can be used for all higher education expenses (tuition, room & board, food, books, computers, supplies, etc.) | |
| States may allow up to $10,000 per year in primary and secondary school tuition costs | |
| No limit on the number of accounts that can exist per beneficiary | |
| Generally have a low impact on financial aid eligibility | |
| If the beneficiary receives a scholarship, dies or is disabled, the 10% penalty on withdrawals may be waived | |
| There are generally no beneficiary age restrictions | |
| Can invest in non-residing state’s plan |
Prepaid Tuition Plans
Prepaid tuition plans are sponsored by the state or by the higher education institutions themselves. The donor buys credits at today’s tuition rates to essentially “lock in” the amount paid for a particular college or group of colleges. The credits are used to pay future tuition costs, even if the price of tuition increases significantly.
| Advantages | Disadvantages |
| Tax-deferred growth and tax-free qualifying distributions | If the beneficiary attends a non-participating college with higher costs, the plan may not cover the full cost of tuition |
| Contributions are income tax deductible in some states | Few states continue to offer plans, and many state programs have residency requirements |
| High limits—most states’ contribution limits exceed $300,000 per beneficiary | Many plans limit distributions to tuition and mandatory fees |
| Contributions qualify for the annual gift tax exclusion (i.e., $15,000 in 2019) | Upside investment potential is limited to the growth in the cost of the covered college’s tuition |
| Accelerated gifting allows individuals to contribute 5 years of gifts ($75,000 per beneficiary) into a single tax year | There may be a required waiting period prior to withdrawals |
| The assets are excluded from the donor’s gross estate | Plans may not allow a non-qualified withdrawal of earning |
| The account owner retains control & may change the beneficiary to a different qualified family member2 tax-free | If allowed, earnings will be taxable as ordinary income and incur a 10% penalty |
| Non-qualified withdrawals of contributions may incur retroactive state income taxes |
The 10% Federal early withdrawal penalty is waived on the full amount of total education expenses incurred for a given year, however, a portion of earnings will be taxable if withdrawn for expenses that were already paid by other sources of tax-free financial assistance (i.e., tax-free financial aid, scholarships, tax credits such as the Lifetime Learning Opportunity Credit, tuition paid by family or friends, etc.).
This commentary is for general education purposes only and should not be construed as a recommendation for any one of the various vehicles. We encourage you to discuss the tax implications of the various structures with qualified tax and legal professionals prior to establishing a 529 Plan.
To learn more about navigating the college application process and financing the cost of higher education, watch our webinar, College 101: Focus on Finances.
Consult with an attorney or a tax or financial advisor regarding your specific legal, tax, estate planning, or financial situation.
1For the purpose of changing the designated beneficiary, a “member of the family” includes: children, grandchildren, step-children, siblings, step-siblings, parents, grandparents, step-parents, nieces, nephews, aunts, uncles, in-laws, the spouse of any of those listed above, first cousins, and spouse. If the donor is a member of the family, the beneficiary could be changed to the donor.
2For the purpose of changing the designated beneficiary, a “member of the family” includes: children, grandchildren, step-children, siblings, step-siblings, parents, grandparents, step-parents, nieces, nephews, aunts, uncles, in-laws, the spouse of any of those listed above, first cousins, and spouse. If the donor is a member of the family, the beneficiary could be changed to the donor.
