February is Financial Aid Awareness Month, created to provide parents, students and families with the education and resources to make the most effective decisions as it relates to financial aid. Every year parents and students are required to complete the Free Application for Federal Student Aid, or (FAFSA), to determine their eligibility for student financial aid, which comes in the form of grants, scholarships, student loans or work study programs.
The average cost of college in the U.S. is $35,551 per year and rising, which has placed an enormous strain on household budgets, finances, and retirement plans. As a result, parents and grandparents alike are aggressively saving for college through 529 plans, Coverdell Education Savings Accounts (ESA) and Uniform Transfer to Minors Act/Uniform Gift to Minors Act or UTMA/UMGA accounts.
Here is the impact that these savings vehicles may have on financial aid.
The Expected Family Contribution (EFC)
The EFC is an estimate of how much a family can afford to contribute toward college expenses. It’s driven by a family’s income and assets as reported on the FASFA. Families with higher incomes and assets will have higher EFCs and be expected to contribute more toward college expenses (think less financial aid), while families with lower incomes will have lower EFCs and be expected to contribute less.
UTMA/UGMA allows custodial accounts created by adults (parents) for the benefit of a minor (their child). It provides the widest array of investment options such as stock, bonds, mutual funds, ETFs, etc. However, once the child reaches the age of 18 or 21, depending on the state, they take full possession of the account. Funds within a UTMA/UGMA can be used for anything, college expenses, car purchases, etc.
Outside of the kiddie tax ($2,300 in earnings or greater depending on parent’s tax rate) there are no significant tax benefits. While there is no maximum amount a parent can invest through an UTMA/UGMA, any amount above this year’s annual gift tax exclusion ($17,000 for single, $34,000 for married) will require an additional IRS filing. UTMA/UGMAs are considered an asset of the child, which means 20% of its value will be counted as part of the expected family contribution (EFC) or the amount a family is expected to contribute toward college.
Coverdell Education Savings Account (ESA)
Also known as an Education IRA, Coverdell ESAs work very similar to IRAs in that they are tax deferred accounts, but they are used for college expenses. They provide a wide array of investment options such as stocks, bonds, mutual funds, etc. However, the maximum annual contribution limit is $2,000. The income requirement also limits who can contribute to a Coverdell; a single person and married couple’s income cannot exceed $110,000 and $220,000, respectively. Coverdell ESAs can only be created for children aged 18 and younger. In addition, funds must be used before age 30. Coverdell ESAs are considered a parental asset and will only account for 5.64% of the EFC.
529 College Savings Plans
By far the most popular savings vehicles, 529 plans offer tax deferred growth with deductions at the state level depending on the state. Investment options are limited to just mutual funds within the plan, however, 529 plans are structured in such a way that almost anyone can contribute. Contributions are tied to the annual gift limit not considered gifts and not taxed. They also allow for super funding; anyone can contribute five years of gifts at once. This would be $85,000 and $170,000 for single and married couples, respectively. Not only can funds be used for college educational expenses, but they can also be used for K-12 expenses ($10,000 per year), student loans and with the passage of the Secure Act 2.0, retirement savings. Considered a parental asset, their value only accounts for 5.64% of the expected family contribution.
Saving for college education is important but not always easy, so be sure to consider it in your financial planning discussions with your certified financial advisor.
Donald Lyons is a Wealth Strategist with Bryn Mawr Trust. With 20 years of experience in wealth management, he provides high-net-worth clients with fiduciary and investment management services. Lyons provides comprehensive financial planning focused on income replacement, asset management, incapacity, and estate planning. He also has experience working with endowments, foundations, and other nonprofit institutions.