Families who can afford the cost of high-end private education sometimes think they don’t have to be strategic about how to pay for this major expense. But that is not what we advise. How you pay for education can help lower a variety of taxes, while also getting your children and grandchildren to the schools that are just right for them. Below, LNWM Client Advisor Monica Padineant presents some tax-friendly ways parents and grandparents can pay for this most-valuable of assets.

Q&A with Monica Padineant, LNWM Client Advisor

Q: Monica, why do people who can afford to pay for college out-of-pocket strategize about this? 
Monica: Paying for education can be very fulfilling in and of itself, but it can also be part of financial and estate planning to minimize a variety of taxes. Here at LNWM, we help families strategize about the best ways to go about this.

Q: Why not pay tuition directly as it comes due?
Monica: The easiest thing to do is to pay the tuition directly, on behalf of your child or grandchild. As long as you make the payments straight to the school, and you pay only for tuition, all these payments are not counted in terms of gift/estate taxes.

Q: What if you also want to pay for room and board?
Monica: Of course you can also pay for this and any other expenses. In addition to full tuition, another $15,000 annually per child is exempt from gift taxes ($30,000 if both you and your spouse are giving). Above that, however, you are required to file a gift tax form (IRS Form 709), and the amount of overage will eat into your lifetime exemption from estate taxes at the federal level. A big plus these days is that the federal estate tax exemption has been doubled to roughly $11.4 million per person, at least through 2025; however, some states, including WA, charge their own estate taxes starting at much lower amounts, and those remain in place.

Q: What are other options for funding higher education?
Monica: If you have time to plan ahead, you can use your annual gift-tax exemption ($15,000 annually per person) to fund education-investment plans.

Section 529 Plans are sponsored by states, state agencies and universities. Your child or grandchild would be the beneficiary of such accounts. But the account owner (usually the parents or grandparents) can change the beneficiary any time. The beneficiary can even be the account owner.

The money in 529 Plans grows tax-free and can be withdrawn tax-free, as long as it’s used to pay for education at a qualifying institution: most US colleges and universities and some foreign schools. US elementary and high school are now also covered but to a lesser degree: Up to $10,000 annually can be withdrawn to pay for K-12. If withdrawals are not used for qualified education, they are taxed on any appreciation (income and capital gains) plus there’s a 10% penalty.

There are two types of 529 plans:
(1) 529 pre-paid tuition plans — let you lock in the price of tuition and fees at current rates (usually not room and board). Pre-paid plans usually limit you to certain schools and there’s often a conversion formula if you go outside the network.
(2) 529 college-savings plans — aren’t guaranteed to cover tuition, so they’re subject to investment risk. However, withdrawals can be used to pay for all sorts of school expenses in addition to tuition, and contribution limits often exceed $200,000.

The big advantage of 529 college-savings plans: You can front-load five years’ worth of giving and still keep within the annual gift-tax exemption: $15,000 x 2 (you and your spouse) x 5 years. What this means: Up to $150,000 can be front-loaded into a 529 Savings Plan account (assuming a married couple are both contributing $75,000 each), with no taxes due on annual appreciation or withdrawals, as long as the money is used to pay for qualified education. There is no time limit on how long the money can remain in a 529 account. And the beneficiaries can be changed at any time.

For more info on 529 plans, one good resource is www.savingforcollege.com, where you can also see which colleges and universities qualify. We have written extensively about 529 Plans, including the 529 started by Washington State in 2018 called DreamAhead.