Close Close

Financial Planning > College Planning > Saving for College

College Savings Demystified: The Devil Is in the Details

Your article was successfully shared with the contacts you provided.

College tuition can present one of the largest pre-retirement expenses that a client will encounter—and the methods for funding those expenses extend far beyond the typical savings account. The tax and non-tax considerations that arise in determining how to pay, and who will pay, for higher education expenses are as varied as the available funding options. 

Regardless of whether a client has been planning to fund a child’s education costs for years or has unexpectedly decided to return to school, it’s important to be prepared for the detailed situations that will round out your client’s individual funding scenario—and those scenarios may involve a 529 plan or require a more creative approach.

529 Plan Scenarios

IRC Section 529 college savings plans are essentially accounts that are funded with after-tax dollars that are permitted to grow on a tax-free basis, so that distributions from the account are not taxed when received so long as they are used to pay for qualified higher education expenses.  Anyone can set up a 529 plan and anyone can be named as beneficiary, though the beneficiary designation can be changed without penalty (for example, if one child decides not to attend college, those funds can be used to fund a sibling’s education without penalty).

If the client anticipates that a third party (such as a grandparent) will be making contributions to the 529 plan, it is important to check to ensure that the plan allows these contributions. While some plans allow anyone to contribute, others restrict contributions to the account owner.

In general, contributions are limited to the amount of education expenses that the beneficiary will incur because amounts over and above those expenses will be taxed upon distribution. However, regardless of who contributes, it is important to remember that the contribution is a gift that will generate gift tax liability if the annual contribution of any individual exceeds the annual gift tax exclusion amount (currently, $14,000).

However, in the case of 529 plans only, a taxpayer is eligible to make a large gift to the 529 plan and elect to treat that gift as though it was spread over a five-year period for gift tax purposes. Therefore, in 2015, a taxpayer could contribute $70,000 ($140,000 for a married couple) without gift tax liability to a beneficiary’s 529 plan if he or she files a gift tax return and makes the election on that return.

While a state tax deduction may be available for 529 plan contributions, if a grandparent or other relative is making the contribution, it is important to check to see whether the state permits a non-account owner to take the deduction.

Funding With Retirement Plan Dollars

Funding with IRA or 401(k) dollars can, at first glance, seem to be an attractive option—especially for clients who have unexpectedly decided to return to school later in their careers. However, it’s important to note that these funds will be taxed at the client’s ordinary income tax rate. Further, these distributions can also impact the client’s ability to qualify for financial aid dollars that might be available absent the extra income from retirement account distributions.

Perhaps most importantly, the client’s eventual ability to replenish the retirement accounts should be considered, as he or she could lose years’ worth of earnings on previously earmarked retirement funds while completing his or her degree.

A Grandparent’s Direct Funding

If a grandparent or other relative funds the student’s tuition expenses directly, the gift tax considerations that are important in the 529 plan context cease to apply.  However, no tax deduction is available because the relative is making the payments to the school in exchange for the student’s education (i.e., such payments do not qualify as charitable donations).

Additionally, these “contributions” will impact the student’s eligibility for financial aid, as they are counted as support payments regardless of who makes them.


Funding a college education can raise a variety of questions—as these expenses can be some of the largest that your clients will face during their working years, it’s important to be prepared with the details necessary to make the smartest funding choices.

For more on college planning, see:

Which College Majors Are Solid Investments?

11 Best & Worst 529 College Savings Plans of 2015: Morningstar

Originally published on Tax Facts Onlinethe premier resource providing practical, actionable and affordable coverage of the taxation of insurance, employee benefits, small business and individuals.    

To find out more, visit All rights reserved. This material may not be published, broadcast, rewritten, or redistributed without prior written permission.