How you can help the next generation pay for college

The cost of a college education has never been higher. These days, a four-year degree has an average price tag ranging from $87,800 for in-state costs at a public university to nearly $200,000 for a private university,1 leaving many graduates with mountains of student loan debt.
And while many parents are juggling mortgages, car loans, other bills and, sometimes, even their own student loans, other relatives or close family friends may find themselves in a unique position of being able to help future students and their parents at the same time. 
The coronavirus pandemic is changing some students’ attitudes toward school. In a March 2020 survey of prospective college students from the high school class of 2020, 17% said they were likely to change their plan of attending a four-year college as a full-time student. Out of that group, 35% said they would take a gap year, and another 35% said they would change from full-time to part-time. About one in 10 respondents said they would enroll in a different type of educational program, such as a community college or an apprenticeship or certificate program.2
That means if you want to help someone with their future educational costs, you may want to start by being sure you understand their goals and needs in what could be a changing environment for higher learning.
When it comes to paying for college, many smart savers begin with a 529 education savings plan. Even during the economic downturn caused by the coronavirus pandemic, most 529 savers have found ways to continue contributing to their plans.3 But there are other ways you may be able to help out as a benefactor, too. Here we’ll run through some of the potential benefits of contributing to a nonparent 529 plan for a future student, and then we’ll discuss other options for helping financially.

Setting a college savings goal

Future tuition costs can be unpredictable, especially when saving for college many years in advance. The current average cost of tuition is a good starting point for setting a savings goal.

Four things to consider with 529 plans

1. They’re one of the most popular ways to save for college. Named for Section 529 of the Internal Revenue Code, this investment tool comes in two varieties.
Prepaid tuition plans let you lock in today’s tuition rates at in-state colleges—protecting you from future increases—and pay off the amount over time. But they’re only offered in a handful of states.
College savings plans are much more common. They’re available in every state, and the money in them can be used at universities in any state. As with a 401(k), 403(b) or IRA, money contributed to a 529 plan is typically invested in the account owner’s choice of selected mutual funds or other investment options.
The earnings on any contributions aren’t subject to federal income tax as long as they’re used for qualifying college expenses (which include tuition and fees, room and board, books, computers, and more). If you use 529 earnings on nonqualified expenses, they are subject to taxes and a 10% penalty.
2. Anyone can contribute to a 529 plan, regardless of who owns the account. So, if a student’s parents have already opened a 529 plan, you can put money into it. If you want to have more influence over the way the money is invested or who can use it, you can also open a 529 plan or a custodial 529 plan yourself. The major difference between a traditional 529 and a custodial 529 is that with a custodial plan, the beneficiary gets control of the account once he or she reaches legal age. Until that time, the account must be managed in the best interest of the future beneficiary, which means you can’t remove money from it.
Make sure everyone—you, the student beneficiary, and the beneficiary’s parents—understands the impact your gift will have on the student’s ability to receive financial aid and on taxes. A custodial 529 plan in a student’s name counts as a parental asset on the Federal Application for Student Aid (FAFSA), as does a traditional 529 plan owned by a parent, as long as that student is still considered a dependent for tax purposes. Parental assets can reduce need-based aid eligibility by as much as 5.64% of the asset value.
A 529 plan owned by anyone else is not considered on the FAFSA application, but distributions from the account (the withdrawals made by the student to help pay for expenses) count as untaxed income for the beneficiary and therefore can reduce eligibility for need-based aid by as much as 50% of the distribution amount. Check with your advisor and tax professional for the specifics of your situation and to help determine which funding method may work best for you.

A 529 account can affect a student's federal financial aid

It's important to review financial aid implications before withdrawing funds.
3. Contributing to a 529 can help you manage your taxes, from estate taxes to income taxes. If one of your goals is to avoid leaving your heirs with hefty tax penalties after your death, making a large contribution to a 529 plan can help. Just be sure not to exceed the annual gift tax exclusion amount ($15,000 for individuals or $30,000 for married couples), or you’ll have to report the gift to the IRS, although in most cases no tax will be due.
There is, however, a way to make larger contributions to 529s, using five-year gift tax averaging. You can deposit up to $75,000 (or $150,000 for married couples), and the money will be treated as if it were given incrementally over five years. That means you can front-load the account as long as you don’t make additional contributions that exceed the annual gift tax exclusion amount during those five years. A tax advisor can help you sort through the tax implications of contributing to a 529 plan.
Depending on your state of residence and the specifics of the 529 plan you contribute to, your gift may also earn you an income tax deduction. In some states, the deduction is only available to the account owner, so that may help you determine whether you want to contribute to a student’s existing 529 plan or start an additional one for the student on your own.
4. As 2020 has taught us, even the best-laid plans can change. What if the person you opened a 529 account for decides on a different path that doesn’t include college? Or the student gets a full-ride scholarship and doesn’t need the money anymore? When plans change, 529 accounts can be used for another type of school, such as graduate school, or the beneficiary can be changed to anyone in the person’s immediate family. If your beneficiary receives scholarship money, you can withdraw that total amount from the 529 account without having to pay a penalty, though you may need to pay taxes on the earnings. Be sure to consult with a tax professional in this situation.
During the recent coronavirus pandemic, many schools provided students with refunds for a portion of tuition or room and board due to facilities closing and classes being held virtually. It’s important to remember that in such circumstances, that refund must be redeposited into the 529 plan or the account owner may be subject to penalty. If students delay starting or returning to college until the pandemic subsides, their 529 plan will not be impacted by the gap in their education.

Four Ways to Think Outside the 529

If you decide a 529 plan isn’t right for you, there are plenty of other ways to help your relative or friend’s child prepare for college.
  1. Give cash. Outright cash gifts are always appreciated. Just be aware of tax implications for larger gifts, and keep in mind that they may count against the student’s financial aid more than money in a 529 plan would.
  2. Pay off the student’s debt. Consider waiting until the student finishes college and then pay off—or help pay off—student loans. This strategy also gives the student incentive to finish school, if that’s something you’re concerned about.
  3. Pay the university directly. Paying the student’s tuition directly to the school is not considered a cash gift, so there are no tax implications to worry about. But it could negatively affect how much financial aid the student can obtain the next school year.
  4. Buy U.S. savings bonds or set up an educational trust fund. Certain savings bonds have tax benefits when used for qualifying education expenses, and you can set up trust funds for use while you’re still living or after your death.
Of course, money isn’t everything. A young person can also benefit from your lifetime of experience. Helping someone learn about budgeting and financial responsibility could be your most valuable gift as that person heads out into the world for the first time.
If you’re considering helping someone with educational expenses, talk to your financial advisor about your goals. Your advisor can help you determine the best path forward, keeping an eye on how the contributions may impact other goals you may have.
Please refer to the Plan Disclosure Book on a state 529 plan’s website prior to investing for details on risk, tax benefits, charges and expenses, and whether your home state offers tax or other benefits, such as financial aid, scholarship funds, or protection from creditors for investing in its own 529 plan. Investments in the Plan are neither insured nor guaranteed and there is the risk of investment loss. Consult your legal or tax professional for tax advice, including the impact of the new federal tax changes.
1“Average Cost of College & Tuition,”, as of June 2020
2“Impact of the COVID-19 Pandemic on College-Going High School Seniors,” Art & Science Group LLC, March 2020
3“Using a 529 Plan to Save for College During COVID-19,”, 2020
The TIAA group of companies does not provide legal or tax advice. Please consult your legal tax advisor.
This material is for informational or educational purposes only and does not constitute fiduciary investment advice under ERISA, a securities recommendation under all securities laws, or an insurance product recommendation under state insurance laws or regulations. This material does not take into account any specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on the investor’s own objectives and circumstances.