What’s the right strategy for funding my child’s education?

As a parent, there’s nothing quite like the desire to see your child succeed. And for most of us, a huge part of that success is making sure they have access to a good education. 

However, for us, funding that education goes beyond just saving money, it’s about strategy. With rising tuition costs and so many options to choose from, how do you ensure your child’s education funding is secured without throwing your own financial plans off track?

In this week’s “money question”, we’ll explore the best strategies for funding your child’s education while keeping your overall financial picture in mind.

Setting Your Education Funding Goals

Before jumping into specific strategies, it’s important to start with clear goals. Funding your child’s education can mean different things to different families. 

Do you plan to pay for tuition only, or will you also cover living expenses, books, and travel? Will your child go to an in-state public school, or are you considering private or out-of-state institutions?

What Are Your Priorities?

As a financial planner, I often hear clients say, “I want to give my child the best, but I don’t want to jeopardize my retirement or other goals.” This is a very valid concern. 

You’ve worked hard to build wealth, and it’s essential that you don’t compromise your long-term financial security for short-term educational expenses.

Timeline Matters

Another key question is: How much time do you have to save? If your child is young, you have more flexibility to invest in higher-growth options. But if college is just around the corner, you’ll want to shift toward more conservative investments that won’t be as affected by market volatility.

In my experience, I’ve found that many parents also underestimate non-tuition costs. While we focus on tuition, other expenses:

• housing, 
• books, 
• meals, 
• Travel

These can add up quickly. So, it’s essential to have a realistic sense of the total cost of your child’s education.

Exploring Your Savings Options

Once your goals are set, the next step is to decide on the right savings vehicles. The good news is, you have several great options at your disposal.

529 College Savings Plans

If you’re thinking about education savings, you’ve probably heard of 529 plans. These are one of the most popular and tax-efficient ways to save for education.

With a 529 plan, you can contribute after-tax dollars, and your investments grow tax-free. Best of all, when it’s time to withdraw the money for qualifying educational expenses, those withdrawals are tax-free too.

For high-net-worth families, a big benefit of 529 plans is that you can contribute significant amounts, up to $18,000 per year per child (in 2024) without triggering gift tax implications. You can also front-load five years’ worth of contributions (up to $90,000 per child) in a single year if you want to give your investment a big boost.

Example from My Practice

One of my clients, a couple with two kids, decided to front-load their 529 plans when their children were young. They contributed $150,000 between the two kids in just one year. 

Thanks to the power of compounding, they saw significant growth, and by the time their eldest reaches college age, they are on track to have more than enough to cover in-state tuition and other expenses.

The downside? If your child doesn’t use the funds for qualified education expenses, you’ll face taxes and a 10% penalty on the earnings. 

But there are ways to work around this, 529 plans allow you to change the beneficiary to another family member, or you could use the funds for your own education.

Coverdell Education Savings Accounts (ESAs)

Coverdell ESAs are another tax-advantaged option, but they come with a lower annual contribution limit, $2,000 per child per year. The upside is that Coverdell ESAs are more flexible when it comes to eligible expenses. 

Keep in mind that beneficiaries who reach the age of 30 must distribute the Coverdell ESA within 30 days. Also, income limits apply, which could limit your eligibility if you’re in a higher tax bracket.

Coverdell Education Savings Account, contribution phase outs for 2024: 

• Single $95,000 — $110,000 
• Married filing jointly $190,000 — $220,000

UTMA/UGMA Custodial Accounts

A UTMA (Uniform Transfers to Minors Act) or UGMA (Uniform Gifts to Minors Act) account allows you to transfer assets to your child in a custodial account. These accounts offer more flexibility in terms of what the money can be used for, there’s no requirement that the funds go toward education. 

However, these accounts come with a few potential downsides.

Tax Considerations

Income generated in a UTMA or UGMA is taxed at your child’s tax rate, which is typically lower than yours. However, if the income exceeds certain thresholds, it will be taxed at your (higher) rate under the “kiddie tax” rules.

Additionally, these accounts are considered the child’s asset, which can negatively impact financial aid eligibility.

While these accounts might not be the first choice for education funding, they could be an option if you want to give your child greater flexibility in how the money is used.

Advanced Strategies for High-Earning Families

High-net-worth individuals often have more complex financial situations, which means you may benefit from advanced strategies beyond traditional education savings accounts.

Using Trusts for Education Funding

One of the most powerful tools for high-net-worth families is the use of trusts. Setting up a trust for education purposes allows you to control how and when your assets are distributed. 

A trust can also protect assets from creditors, and in some cases, offer tax advantages. For instance, you could set up a family trust that includes specific instructions about how much should be allocated toward education and under what conditions. 

Trusts can be especially useful if you want to ensure the funds are used for education, but also want to preserve flexibility for other purposes.

Gifting and Estate Planning Strategies

If you’re looking to reduce your taxable estate, consider using the annual gift tax exclusion to contribute to your child’s education fund. In 2024, you can give up to $18,000 per year, per person, without paying gift tax. 

Married couples can give up to $36,000. This is another way to help fund your child’s education while reducing the size of your taxable estate.

Some families even set up charitable scholarships or educational endowments as part of their legacy, allowing them to support future generations while enjoying significant tax benefits.

Cash Flow Strategies

Don’t overlook cash flow management as part of your education funding strategy. If you’re a high-income earner, you may have excess cash flow that can be allocated to education savings without needing to tap into other investments. 

Also, tuition payments can be paid directly to the school / institution and those payments can be made without paying gift taxes.

This way, you can continue to grow your long-term wealth while securing your child’s education at the same time.

Planning for Multiple Children or Educational Paths

What if you have more than one child? Funding multiple educations can complicate your plan, but it’s definitely manageable with the right approach.

Tailoring Your Strategy

Each child may have different educational needs, and your strategy should reflect that. For example, one child may choose a private college while another attends a state university. 

In this case, you might prioritize tax-advantaged accounts for the child with higher anticipated expenses and use cash flow or trusts for the other.

And remember, education doesn’t just mean college, funds from a 529 plan or other accounts can also be used for trade schools or other non-traditional educational paths.

Avoiding Overfunding

One concern many parents have is overfunding. What happens if you save too much? 

This is especially relevant for high-net-worth families who may front-load 529 plans or other accounts. To avoid this, I often recommend reviewing your education funding strategy regularly and staying flexible.

If your child doesn’t use all the funds for their education, you can repurpose the excess. For example, you can change the beneficiary of a 529 plan to another family member or even use it for your own continuing education.

Preparing for Financial Risks

As you plan for your child’s education, it’s essential to account for potential risks.

Inflation and Rising Costs

Education costs are notorious for rising faster than inflation. Over the past few decades, tuition has increased at rates far outpacing general inflation. 

To hedge against this, make sure your education savings strategy includes investments that can outgrow inflation, especially if you’re starting early.

The Financial Aid Puzzle

It’s easy to assume that high-net-worth families won’t qualify for financial aid, but that’s not always the case. Some colleges (and private colleges) offer merit-based scholarships that aren’t tied to financial need. 

So even if you don’t expect to qualify for need-based aid, it’s still worth exploring scholarship opportunities.

What’s Next for funding my child’s education…

Funding your child’s education is a big decision that requires careful thought and planning. For high-net-worth and high-earning families, it’s essential to strike the right balance between securing your child’s future and maintaining your broader financial goals.

By setting clear objectives, exploring various savings options, and leveraging advanced strategies like trusts and gifting, you can ensure that your child receives the education they need without compromising your financial well being.Need help developing the right strategy? Reach out to a Certified Financial Planner to discuss how you can tailor these strategies to fit your unique financial situation.