Education Savings Planning

By Donna Walton, Wealth Strategist

Paying for college can be a daunting prospect for many families. Saving for a child's education is one of the biggest investments many people will make over their lifetime. The costs of higher education continue to climb. Tuition, room, board, and mandatory fees are not the only expenses for which you need to plan. There are also travel and other incidental expenses that can add to the overall cost.

Education savings planning should be an integral part of your overall financial plan. Ideally, it should be balanced with your other goals including retirement and estate planning goals to improve overall outcomes. There are a variety of ways to save for college. The most popular vehicles used to save for college expenses include Uniform Transfers to Minors Act (UTMA) accounts, 529 plans, Coverdell ESAs and irrevocable trusts. All are funded with irrevocable gifts, including annual exclusion gifts ($19,000 in 2025), but each has its own benefits and limitations. Whatever vehicles you choose to save to fund higher education, it is important to start saving as early as possible.

529 education savings plans
529 education savings plans are state sponsored investment vehicles that allow you to put after tax money into an investment account on behalf of a designated beneficiary, usually a child or grandchild (though it could be a niece, nephew or even a non‐family member). Contributions are not federally tax deductible but may be state tax deductible. You should consult your tax professional before deciding. They can also be used for private elementary and high school tuition. The contributions in a 529 plan grow tax deferred. Distributions withdrawn for qualified educational expenses, which include tuition, fees, and books are tax free. Distributions that are not made for qualified educational expenses are taxable and subject to a 10% penalty. There are no income limitations.

You can pre‐fund a 529 plan using 5 years of your annual exclusion ($19,000 in 2025) to front load the plan. In 2025, that would be $95,000 or $190,000 per married couple.

You must choose the investment options offered by the 529 plan and you can typically only reallocate investments twice a year. It is important to do research into the options of different 529 plans before deciding on a plan.

Another benefit of a 529 plan is that you can change the beneficiary if the initial beneficiary decides not to go to college or does not use all the funds in the plan. The beneficiary can be changed to family members in the same generation or even yourself. Changing the beneficiary to a beneficiary in a later generation could have negative tax ramifications. Make sure to check with your tax advisor before making the change.

529 plans accept third party contributions so other family members can also contribute.

Prepaid tuition plans
Prepaid tuition plans are a type of 529 plan. Essentially, they allow you to prepay future tuition at eligible colleges and universities at today's rates. This could amount to significant savings over time. Earnings grow tax deferred and distributions for qualified educational expenses are tax free. Distributions for ineligible expenses ae taxable and subject to a 10% penalty. The credits may be transferred to another child in the family if the initial beneficiary does not use them.

One of the downsides of a Prepaid Tuition Plan is you will need to decide where the student will go to school years ahead of time. They are usually best for people who know their child will go to an in‐state college or university. Another drawback is that most do not cover room and board so additional savings will be needed to cover those as well as incidental expenses. They are also usually only offered to state residents. If the student decides to go to a different school than is offered in the plan there may additionally cost of the tuition which could be substantial.

Coverdell Education Savings Account (ESA)
Coverdell ESAs (formerly known as Education IRAs) are tax advantaged vehicles that work similarly to 529 plans. They must be used for qualified education costs. Distributions for qualified education expenses are tax free. A Coverdell can be used for primary and secondary school expenses as well as higher education expenses. They allow a wide variety of investment options. One of the downsides of a Coverdell is you can only contribute up to $2,000 per year per beneficiary. This amount is phased out based on Modified Adjusted Gross Income (MAGI). Contribution eligibility is phased out for single filers with a MAGI from $95,000 to $110,000, and joint filers with a MAGI of $190,000 to $220,000.

Custodial accounts/UTMA accounts
A Uniform Transfer to Minors Act (UTMA) account is another popular education savings vehicle. It is a custodial account that allows a donor to make an irrevocable gift to a minor child that will eventually transfer to the child at a certain age set by State statute. The donor names an adult custodian to manage the UTMA assets. It is easy to establish an UTMA and the adult custodian determines how the assets will be invested. The funds in the UTMA must be used for the child's benefit. UTMA assets can also be used to benefit the minor, not just for education expenses. A significant limitation to UTMAs, however, is that the UTMA assets must be transferred to the child when the child reaches a certain age. This age varies from state to state. It is generally between 18–21 although some states allow an extension until age 25. If you are concerned your child may not be responsible to manage the account at that age, this might not be the right option. Another drawback of an UTMA is something called the "Kiddie Tax." With the "Kiddie Tax," any portfolio income above a certain level ($2,700 in 2025) will be taxed at the parents' marginal tax rate instead of the child's rate.

Trusts
For some families, setting up an irrevocable trust may be a better savings and wealth transfer vehicle than either a 529 plan or an UTMA account. Irrevocable trusts can be drafted with flexibility to benefit one or more beneficiaries, with distributions being allowed for almost any reasonable purpose and not limited to higher education expenses. There are no maximum funding amounts with irrevocable trusts, and investment choices are flexible. One drawback is that income is taxable, often at a higher trust tax rate. If a family has enough wealth that tuition can be paid by parents or grandparents, then the flexibility of the irrevocable trust becomes even more attractive because the funds can be used for other life goals. The irrevocable trust can continue to be funded with gifts while tuition can, in addition, be paid directly to the educational institution by the parent or grandparent because it does not count as a gift. Another drawback to trusts is that they can be complex and expensive to set up and administer.

Roth IRAs
Roth IRAs are also viable options for education planning. Earnings in a Roth IRA can be withdrawn tax free at 59 ½ (provided it has been at least five years since you first contributed to a Roth IRA). If you are not yet 59 ½, withdrawals of Roth IRA earnings that are used for the educational expenses of a child or grandchild are subject to income taxes but not an early withdrawal penalty. You should consider the ramifications of using any retirement vehicle to fund education expenses as this could impact your own retirement security. Speak to your legal and tax advisors to determine if this is the right option.

Conclusion

Planning for the costs of education can be overwhelming, but there are steps you can take to be prepared. Start saving as early as possible with a savings vehicle or combination of vehicles that are right you and your family. If you can, schedule regular contributions to those accounts. Even small amounts made consistently will add up over time. When calculating costs make sure to account for the full cost of college. Know how much you’ll need to spend on living expenses, textbooks and anything else that might come up. Wherever you are in the planning process an important step you can take is to talk to financial, legal and tax advisors and incorporate your college funding goals into your overall financial plan to help you evaluate your options and help you stay on track with all your financial goals.

TD Wealth does not provide legal, tax or accounting advice.