There are many ways to fund preschool, primary and secondary school, college, graduate and professional education. Described below are some options for funding education.
529 plans can be the cornerstone for the accumulation of assets to help meet the cost of future education. 529 plans 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. 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. Such expenses also include up to $10,000 per beneficiary per year which may be used to pay tuition for grades K through 12. Further, 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).
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, 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.
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 or lifetime exclusion from the gift tax, nor will it cause a gift tax.
Coverdell Educational Savings Accounts
Coverdell educational savings accounts (Coverdells) are trust or custodial accounts established to pay qualified education expenses 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.
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 settlement agreement or judicial modification proceeding to include provisions that allow distributions to be made for younger family members’ educations.
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. Consult your tax advisor to determine if you qualify.
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). There are detailed requirements that must be met to qualify for the credit. Consult your tax advisor to determine if you qualify.
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 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.
Federal and Private Student Loans
The U.S. 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.
Beyond federal loan programs, private borrowing may be considered. PNC 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.
Student Loan Forbearance and Forgiveness
Due to the COVID-19 emergency, payments with respect to federal student loans were suspended and the interest rate on such loans temporarily set at 0%. Waivers and modifications to certain student loans under the CARES Act will end 60 days after June 30, 2023. According to the U.S. Department of Education, “Student loan interest will resume starting on [September] 1, 2023, and payments will be due starting in October.”
In 2022, the Biden-Harris Administration announced a student debt relief plan. On June 30, 2023, the U.S. Supreme Court invalidated this plan.
Help is Available
An investment in education, is still one of the best investments one can make for the future. 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.