Financial Strategies for Funding Education

Over the last year or more, families have overcome many hurdles to educate their children. Virtual, hybrid, and asynchronous learning options are being considered along with the traditional, in-person learning environment. At the height of the pandemic, many parents who desired in-person classroom education for their children or were uncomfortable with their local public schools moved their children to private elementary and secondary schools, with their attendant tuition and fees.

Beyond secondary school, the pursuit of higher education provides great opportunity for many students, but the cost^[1] can burden them with expenses and student loan debt that may, for many years, impact their financial status.

There are many ways to fund preschool, primary and secondary school, college, graduate, and professional education.^[2] While there are many strategies available to fund education, not all will be available to, or right for, each student and family. In the end, a combination of financial resources will probably be needed to finance a student’s education. Life is anything but predictable; planning ahead can help families provide students with the best education possible. Described below are some options for funding education.

529 Plans

529 plans can be the cornerstone for the accumulation of assets to help meet the cost of future education. 529 plans, which are named after the section of the Internal Revenue Code (IRC) directing their tax treatment, allow parents, grandparents, and others to make gifts of after-tax cash to a state-sponsored account, generally invested in mutual funds, which can be used to pay qualified educational expenses.^[3] If assets in the 529 plan are used to pay qualified educational expenses, the growth in the assets contributed to the plan and used for such purposes will not be subject to income tax. As originally created, 529 plans were used for higher education. The law has evolved over time so that now up to $10,000 per beneficiary per year may be used to pay tuition for grades K through 12 without incurring federal income tax.^[4] For parents considering moving their children from public to private primary or secondary schools, the ability to access 529 plans to pay private school tuition may be particularly helpful. However, withdrawing funds from 529 plans to pay primary and secondary school tuition may deplete those plans before they are needed to pay for college.

On the other end of the spectrum, for a student (or a parent with a PLUS loan) who has already incurred student loan debt, 529 plans can be used to repay up to $10,000 of that debt per beneficiary (or sibling of the beneficiary).^[5]

Should circumstances prevent a beneficiary from fully utilizing that beneficiary’s 529 plan, the owner of the account can change the beneficiary to another member of the family,^[6] allowing the funds to be used for the new beneficiary’s education. Families looking to fund education through 529 plans should start early, because tax-free growth is maximized over long-term time horizons.^[7]

Coverdell Educational Savings Accounts

Coverdell educational savings accounts (Coverdells) are trust or custodial accounts established to pay qualified education expenses^[8] for the designated beneficiary of the account, and if used for such purposes, distributions from the account are not subject to federal income tax. Although individuals and entities can contribute to Coverdells, contributions from all sources are limited to $2,000 per beneficiary per year. Traditionally Coverdells were used by families saving for private elementary and high school (although they can also be used for college).^[9]

IRC Section 2503(e)

Payments from family members directly to an educational institution are, perhaps, the simplest way to pay education expenses. IRC § 2503(e) excludes from a donor’s taxable gifts amounts paid directly to an educational institution on behalf of an individual for tuition. As a result, direct payments of tuition will neither consume a donor’s $17,000 annual exclusion^[10] or lifetime exclusion from the gift tax, nor will it cause a gift tax. It is important to remember that qualifying payments under IRC § 2503(e) may only be used to pay tuition directly to the educational institution; such payments may not be used for books, supplies, room and board, or similar expenses.^[11] Taking full advantage of the exclusion from taxable gifts offered by IRC § 2503(e) can also be an estate planning opportunity for senior generation family members, as such payments can reduce their gross estate (and potential estate tax). The benefit is amplified for grandparents and great grandparents as the exclusion allowed by IRC § 2503(e) permits them to make additional transfers that benefit grandchildren and great grandchildren without using any of their exemption from the generation-skipping transfer tax.^[12]

Trust for Education

Families create trusts for many reasons; some trusts are designed to save taxes, some to protect assets from creditors, some to provide for disabled family members, and some to build and preserve wealth over many generations. At its most basic, the trustee holds and invests wealth and uses that wealth for the trust’s beneficiaries as directed or allowed by the terms of the document creating the trust. For families whose senior generation members have already funded trusts, perhaps their terms allow them to be used to pay for children’s or grandchildren’s education. Even if the trusts don’t allow distributions for that purpose, perhaps the trust can be modified by using a so-called decanting law, a non-judicial or judicial settlement to include provisions that allow distributions to be made for younger family members’ educations.

Many of the strategies for preserving estate and gift tax exclusions involve gifts to trusts. Families considering these strategies, could consider adding trust provisions allowing funds in the trust to be distributed to provide for younger family members’ educations. In many states these trusts can be made perpetual and can avoid future estate, gift and generation-skipping transfer (GST) taxes by allocation of the donor’s GST exemption. Such trusts could provide education benefits to many generations of the family.

Senior generation family members who have already fully utilized their exemptions from the GST, or who wish to save it for use in other estate planning transactions, could consider establishing Health and Education Exclusion trusts (HEET).

The HEET trust is not exempt from the GST tax, as the donor who creates it does not allocate GST exemption to the trust. Accordingly, the trust should always have a beneficiary, such as a child of the donor or a charity, which would prevent the trust from being subject to the GST tax. The HEET trust may only pay for its individual beneficiaries’ tuition and medical expenses, as these distributions qualify for the exclusion from taxable gifts under IRC § 2503(e) and would, therefore, also be exempt from the GST tax.^[13] In this manner, a grandparent can set aside assets for grandchildren’s (and more remote descendants’) education without allocating GST exemption to the trust, leaving GST exemption available for other estate planning.

Trusts (other than HEET trusts) can provide great flexibility to families seeking to fund education expenses. Distributions from a trust are limited only by the trust’s terms. Thus, if the terms of the trust allow, distributions may be made from the trust to meet expenses that would not be qualified education expenses if made from a 529 plan, such as preschool or daycare expenses.

Federal Tax Credits

The American Opportunity Tax Credit provides a federal income tax credit of up to $2,500 for the cost of higher education tuition, fees and course materials paid during the taxable year. Up to 40% of the $2,500 credit is refundable, which allows taxpayers to receive up to a $1,000 federal income tax refund even if they owe no federal tax. Taxpayers who have a modified adjusted gross income (MAGI) of $80,000 or less ($160,000 or less for married taxpayers filing a joint federal income tax return) can claim the full credit for qualified expenses of an eligible dependent student. The credit is reduced if MAGI exceeds those amounts, and is completely phased out when MAGI is greater than $90,000 ($180,000 for married taxpayers filing a joint federal income tax return). The credit may be claimed only for four years. There are detailed requirements that must be met to qualify for the credit; therefore, consult your tax advisor to determine if you qualify.^[14]

The Lifetime Learning Credit is another federal income tax credit that may help pay for education. Taxpayers may claim a lifetime learning credit of up to $2,000 for qualified education expenses paid for all eligible students. There is no limit on the number of years the lifetime learning credit can be claimed. The credit is not refundable. Accordingly, while the credit may reduce a taxpayer’s federal income tax to zero, if the credit is more than the tax, the excess won’t be refunded. The amount of the lifetime learning credit is gradually phased out if the taxpayer’s MAGI is between $80,000 and $90,000 ($160,000 and $180,000 for married taxpayers filing a joint federal income tax return).^[15] There are detailed requirements that must be met to qualify for the credit; therefore, consult your tax advisor to determine if you qualify.^[16]

The American Rescue Plan Act of 2021^[17](ARPA) included additional COVID-19 relief available through September 30, 2023, for higher education institutions and students.^[18]A portion of the funds must be used for grants to students.^[19] The COVID-related Tax Relief Act of 2020.^[20] (the CTRA) provides that qualified emergency financial aid grants (other than the portion of such grants paid for teaching, research, or other services provided as a condition of receiving an emergency financial aid grant) shall not be included in the grant recipient’s gross income.^[21] The exclusion from income also applies to such grants derived from ARPA.^[22] Higher education expenses paid with amounts not included in income (except gifts, bequests, devises, and inheritances within the meaning of IRC § 102(a)) may not be used to claim the American Opportunity credit or the Lifetime Learning credit.^[23] Nevertheless, even though the CTRA provides that qualified emergency financial aid grants shall not be included in the grant recipient’s gross income, the CTRA also provides that such grants will not limit the student’s ability to qualify for either tax credit.^[24] This provision of the CTRA applies to qualified emergency financial aid grants made after March 26, 2020.^[25]

Scholarship Options

Private scholarships offer another opportunity to help fund education. Various affinity, religious, and fraternal organizations have scholarship programs. Some scholarships are merit based, others are need based or limit eligibility to those with certain backgrounds or affiliations. Many students and families exploring scholarship opportunities are surprised to learn that their local church or employer offers scholarships that can partially fund education expenses. While competition for the nationally competitive scholarships can be an option for top students, starting local and being creative can help unlock options to make college more affordable for many students.

Work-Study Options

Work-Study programs and other federal programs at colleges and universities offer an attractive option to simultaneously gain valuable work experience and help offset the cost of education. Part-time work, generally on-campus, is offered to both undergraduate and graduate students demonstrating financial need.^[26]

Federal and Private Student Loans

Even with scholarships, family savings and trusts, many students will still need additional funds to finance their education. Borrowing, either through Federal direct loan programs or private loan options, is often necessary.

The US Department of Education offers eligible students at participating schools Direct Subsidized Loans and Direct Unsubsidized Loans (sometimes referred to as Stafford Loans or Direct Stafford Loans). The interest rates for direct federal loans are generally lower than private loans, and the repayment terms for direct federal loans may include provisions for public service debt forgiveness and income-based repayment plan options. The key difference between subsidized and unsubsidized direct loans is that the U.S. Department of Education pays the interest on subsidized loans while the student attends school and during a six-month grace period thereafter, whereas unsubsidized loans accrue interest while the student attends school.

Grad or Parent PLUS loans are another federal loan option to meet education needs, and are generally used after the direct loan limits have been exhausted. Parents are legally responsible for repayment of Parent PLUS loans. For graduate and professional school students, Grad PLUS loans (not involving the parent) are often used to meet the cost of tuition that exceeds direct loan limits.^[27]

Beyond federal loan programs, private borrowing may be considered. PNC^[28] and many other banks offer student loans, which can play an important role when financing tuition and other education expenses. Private loans may also be more flexible than loans offered through federal programs. State agency loans are another private option, as are loan programs which may be offered directly through the school.

Other Borrowing Options

Other lending options families can use to fund education include home equity lines of credit and lines of credit secured by assets held in investment accounts. Each of these options has a unique structure, such as the repayment period and available interest rate.

Borrowing can help bridge the gap between the cost of higher education and what is provided by family, trusts, scholarships and grants. Students and parents should borrow responsibly, and carefully consider the repayment terms on loans, taking into consideration the student’s field of study and future earning potential.^[29]

Student Loan Forbearance and Forgiveness

Payments with respect to federal student loans were suspended and the interest rate on such loans temporarily set at zero (0%) percent. This forbearance has been extended while the U.S. Supreme Court considers the pending proposed student debt relief program (see below). “Payments will resume 60 days after the Department [of Education] is permitted to implement the program or the litigation is resolved .... If the program has not been implemented and the litigation has not been resolved by June 30, 2023 – payments will resume 60 days after that.”^[30]

On August 24, 2022, the Biden-Harris administration announced a student debt relief plan. The U.S. Department of Education will provide up to $20,000 in debt relief for Pell Grant recipients and up to $10,000 in debt relief for others. Income limitations apply. Debtors must apply for this relief. Applications will be accepted until December 31, 2023.^[31]

ARPA included also provision that excludes student debt canceled through 2025 from federal gross income.^[32] Be aware that some states do not follow the federal rules when calculating income subject to tax. Therefore, this loan forgiveness may be subject to income tax in some states.

Help is Available

An investment in education, is still one of the best investments one can make for the future. It is never too late to plan to ensure your family can make the most of its educational opportunities.

Families should seek the advice of their legal, tax and financial advisors when “assembling” the mix of funds required to pay for education.

Your PNC team is available to discuss how your family can achieve success through education funding.

For more information, please contact your PNC Private Bank advisor.

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Important Legal Disclosures and Information

1. National Center for Education Statistics, Tuition costs of colleges and universities. https://nces.ed.gov/fastfacts/display.asp?id=76. Last accessed March 29, 2023.

2. For a general explanation of tax favored education benefits, see, Tax Benefits for Education, IRS Publication 970.

3. “The term “qualified higher education expenses” means-(i) tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a designated beneficiary at an eligible educational institution, (ii) expenses for special needs services in the case of a special needs beneficiary which are incurred in connection with such enrollment or attendance, and (iii) expenses for the purchase of computer or peripheral equipment (as defined in IRC section 168(i)(2)(B)), computer software (as defined in IRC section 197(e)(3)(B)), or Internet access and related services, if such equipment, software, or services are to be used primarily by the beneficiary during any of the years the beneficiary is enrolled at an eligible educational institution”; provided that it shall not include expenses for computer software designed for sports, games, or hobbies unless the software is predominantly educational in nature. IRC § 529(e)(3).

4. IRC §§ 529(c)(7) and (e)(3)(A); Notice 2018-58, 2018-33 IRB 305.

5. IRC§ 529(c)(9), added by Pub. L. 116-94, Division O, § 302.

6. The term “member of the family” means, with respect to any designated beneficiary: (i) the spouse of such beneficiary; (ii) the beneficiary’s child or a descendant of a child; the beneficiary’s brother, sister, stepbrother, or stepsister; the beneficiary’s father or mother, or an ancestor of either; the beneficiary’s stepfather or stepmother, a son or daughter of a brother or sister of the beneficiary; a brother or sister of the father or mother of the beneficiary; a son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law of the beneficiary; (iii) the spouse of any individual described in the preceding clause (ii); and any first cousin of the beneficiary. IRC §§ 529(e)(2) and 152(d)(2)(A)-(G).

7. Beginning in 2024, under certain conditions and subject to specific limitations, a tax and penalty-free rollover of a long-term 529 plan account by its designated beneficiary is permitted to a Roth IRA, for up to $35,000, in the aggregate. The 529 Plan must have been open for at least 15 years and such rollovers are subject to the Roth IRA annual contribution limit. IRC § 529(c)(3)(E).

8. The term “qualified education expenses” means (i) qualified higher education expenses as defined in IRC §529(e)(3), and (ii) qualified elementary and secondary education expenses. IRC § 530(b)(2). The term “qualified elementary and secondary education expenses” means (i) expenses for tuition, fees, academic tutoring, special needs services in the case of a special needs beneficiary, books, supplies, and other equipment which are incurred in connection with the enrollment or attendance of the designated beneficiary of the trust as an elementary or secondary school student at a public, private, or religious school, (ii) expenses for room and board, uniforms, transportation, and supplementary items and services (including extended day programs) which are required or provided by a public, private, or religious school in connection with such enrollment or attendance, and (iii) expenses for the purchase of any computer technology or equipment or Internet access and related services, if such technology, equipment, or services are to be used by the beneficiary and the beneficiary’s family during any of the years the beneficiary is in school; provided however that it shall not include expenses for computer software designed for sports, games, or hobbies unless the software is predominantly educational in nature. IRC § 530(b)(3).

9. Note that Coverdells may be able to pay expenses associated with primary and secondary education that cannot be paid from a 529 plan, which is limited to making tuition payments. See IRC §§ 529(c)(7) and (e)(3)(A); Notice 2018-58, 2018-33 IRB 305.

10. Citizens and residents of the United States may give up to $17,000 per donee per year without using any of their lifetime exclusion from federal gift tax or paying a federal gift tax (known as the “annual exclusion,” because that amount is excluded from the donor’s taxable gifts). IRC § 2503(b). To qualify for the annual exclusion, the gift must be a present interest in property.

11. See Treas. Reg. § 25.2503-6(b)(2).

12. IRC § 2642(c).

13. IRC § 2642(c).

14. IRS, Publication 970, Chapter 2; see also, American Opportunity Tax Credit, https://www.irs.gov/credits-deductions/individuals/aotc (last accessed November 2, 2022). See also, Briefing Book, Key elements of the U.S. Tax System, What tax incentives exist to help families pay for college?, Tax Policy Center, Urban Institute & Brookings Institution, p. 2, https://www.taxpolicycenter.org/briefing-book/what-taxincentives-exist-help-families-pay-college (last accessed, November 2, 2022).

15. See generally, Internal Revenue Service, IRS provides tax inflation adjustments for tax year 2022, IR-2021-219, https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2023 (last accessed November 2, 2022).

16. IRS, Publication 970, Chapter 3; see also, Lifetime Learning Credit, https://www.irs.gov/credits-deductions/individuals/llc (last accessed November 2, 2022).

17. Pub. L. 117-2.

18. Pub. L. 117-2, § 2003; see, also, NASFAA, National Association of Student Financial Aid Administrators, NASFAA Higher Education Emergency Relief Fund III (HEERF III) Reference Page, https://www.nasfaa.org/heerf_iii (last accessed November 2, 2022).

19. NASFAA, National Association of Student Financial Aid Administrators, NASFAA Higher Education Emergency Relief Fund III (HEERF III) Reference Page, https://www.nasfaa.org/heerf_iii (last accessed November 2, 2022).

20. Pub. L. 116-260, Division N, Title II, Subtitle B, § 271(a).

21. CTRA §§ 277(a)(1) and (c). See also, IRS, Higher Education Emergency Grants Frequently Asked Questions, https://www.irs.gov/newsroom/ higher-education-emergency-grants-frequently-asked-questions (last accessed November 2, 2022); See, also, IRS Fact Sheet, IRS revises frequently asked questions for the Higher Education Emergency Grants, FS-2022-11, February 22, 2022, https://www.irs.gov/pub/taxpros/fs-2022-11.pdf (last accessed November 2, 2022).

22. IRS, Higher Education Emergency Grants Frequently Asked Questions, https://www.irs.gov/newsroom/higher-education-emergency-grants-frequently-asked-questions, Q&A 2 and 3, (last accessed November 2, 2022); See also, IRS Fact Sheet, IRS revises frequently asked questions for the Higher Education Emergency Grants, Q&A 8, FS-2022-11, February 22, 2022, https://www.irs.gov/pub/taxpros/fs-2022-11.pdf (last accessed November 2, 2022).

23. IRC § 25A(g)(2).

24. CTRA § 277(a)(2).

25. CTRA § 277(d).

26. Federal Work-Study jobs help students earn money to pay for college or career school, Federal Student Aid, An Office of the U.S. Department of Education, https://studentaid.gov/understand-aid/types/work-study (last accessed November 2, 2022).

27. The U.S. Department of Education offers low-interest loans to eligible students to help cover the cost of college or career school, Federal Student Aid, An Office of the U.S. Department of Education, https://studentaid.gov/understand-aid/types/loans/subsidized-unsubsidized (last accessed November 2, 2022).

28. PNC, Private Student Loans, https://www.pnc.com/en/personal-banking/borrowing/student-loan-center.html. Last accessed November 2, 2022.

29. Consumer Financial Protection Bureau, Student Loans: Choosing a Loan that’s Right for You. https://www.consumerfinance.gov/paying-for-college/choose-a-student-loan/#o1. Last accessed November 2, 2022.

30. U.S. Department of Education, Biden-Harris Administration Continues Fight for Student Debt Relief for Millions of Borrowers, Extends Student Loan Repayment Pause, November 22, 2022, https://www.ed.gov/news/press-releases/biden-harris-administration-continues-fight-student-debt-relief-millions-borrowers-extends-student-loan-repayment-pause (last accessed March 29, 2023).

31. For more information see https://studentaid.gov/debt-relief-announcement/one-time-cancellation (last accessed November 2, 2022). At the time of this writing the student loan forgiveness program was the subject of litigation in the federal courts. On February 28, 2023, the U.S. Supreme Court heard oral arguments in the case. https://www.supremecourt.gov/oral_arguments/argument_calendars/MonthlyArgumentCalFebruary2023.pdf (last accessed March 23, 2023).

32. IRC § 108(f)(5).

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