With the start of the new school year quickly approaching, now is a good reminder that the year will come and go before we know it. College costs are rising with inflation every year that ticks by, so the earlier you start planning, the better. This article will help you prepare for saving for college at an earlier stage, give tips on your savings options if you are closer to college than kindergarten, and other tax credits and deductions you may not be aware of. For the grandparents out there, we are going to talk about what you can do to help. If you are generous and you want to pass an education legacy down, you might be the perfect candidate for a Dynasty 529 Plan for multigenerational college planning.
Most of my friends cried when their kids turned 10. I was the one who cried a year earlier, at age 9. My mindset was that they are halfway out of the house (cheers and sobs!). At ages 10 and 13, my children are now halfway and two-thirds out of the house and the cost of education is not getting cheaper. Thankfully we started saving when they were born, as we did not want the burden of student loans to set them back financially, as it did to my husband and I in our 20’s. Here is a high-level overview of options for K-12 aged children:
Coverdell ESA: A Coverdell education savings account (Coverdell ESA) is a trust or custodial account set up in the United States solely for paying qualified education expenses for the designated beneficiary of the account. This benefit applies not only to qualified higher education expenses, but also to qualified elementary and secondary education expenses. Limited to $2,000 in contributions per beneficiary per year, this option is good for a family who has the means to set aside a small contribution annually. https://www.irs.gov/taxtopics/tc310
529 Plan: A 529 is like a Coverdell ESA, but with a tax deduction and a much larger limit. Contributions are paused once the total aggregate balance across all Arizona 529 plans for a single beneficiary reaches $609,000. They are also known as qualified tuition programs or QTPs. In the state of Arizona, you can deduct contributions from AZ Income tax. The maximum deduction is $4,000 per beneficiary for married couples filing jointly, and $2,000 per beneficiary for individuals (including single individuals and heads of household). Arizona taxpayers can also take advantage of the state's 529 tax deduction when contributing to other states' 529 plans. Beyond the state tax deduction, 529 plans also offer tax-free growth of assets and tax-free withdrawals for qualified education expenses. Qualified expenses include tuition, room and board, textbooks, computers, and other necessary educational supplies.
Under the SECURE Act 2.0, you can roll over unused 529 plan funds directly into a Roth IRA tax-free and penalty-free. However, this provision comes with very specific federal guidelines regarding timelines, ownership, and contribution limits.
Core Conversion Rules
● Lifetime Limit: The maximum aggregate amount you can roll over is $35,000 per beneficiary.
● Annual Limits: Rollovers are capped at the standard annual Roth IRA contribution limit for that year. For example, the 2026 limit is $7,500 (or $8,600 if the beneficiary is age 50 or older).
● Earned Income Requirement: The beneficiary must have earned income at least equal to the amount being rolled over for that year. If they only earn $4,000, the maximum rollover for that year is restricted to $4,000.
● No Income Phase-outs: Unlike regular Roth IRA contributions, the standard maximum income limits (MAGI phase-outs) do not apply to these rollovers.
● 15-Year Rule: The 529 account must have been open for at least 15 years before any rollovers can occur. Be aware that changing the beneficiary may reset this 15-year clock under current interpretations.
● 5-Year Rule: You cannot roll over any 529 contributions—or the earnings generated by those contributions—made within the last 5 years
Planning Tip: Be sure to name a trusted person as the custodian of the account, and successor custodian, as I have seen parents get divorced and wipe out the 529 accounts for living expenses when it was intended as a gift to a minor. In this example, the earnings are taxable and there is a 10% penalty for using the funds for non-educational purposes.
Roth IRA: While not the most conventional way to save, it helps take the, “what if they don’t go,” or, “I don’t want to over-save,” out of the equation. This is also a good option if you already have an established Roth IRA account and you have a middle school or high school aged child.
How it works:
Roth IRAs allow for tax-free growth, and IRS tax code allows tax and penalty free distributions for qualified education expenses for students enrolled at least half-time at an eligible educational institution. There is no 10% early withdrawal penalty, which is typically waived after age 59 1/2 and Roth IRAs are not counted as an asset when considering financial aid. With that in mind, if you take a distribution to pay tuition for say your child’s freshman year, that distribution will be counted as income on your FAFSA. A potential work-around is to have your child take out student loans, get good grades, graduate, and then pay off the student loans with your Roth IRA account, which is also permissible.
Working college students: There are tax credits available to you such as the American Opportunity Tax Credit (AOTC) and the Lifelong Learning Credit.
https://www.irs.gov/credits-deductions/individuals/education-credits-aotc-and-llc
Generous grandparents who care about giving a legacy of education: A Dynasty 529 would be funded by annual gifts or a large one-time lump sum, to provide multigenerational college savings, beyond children and grandchildren.
When a grandparent contributes to a grandchild's 529 plan, it's considered a gift for tax purposes. The current annual exclusion of $19,000 per gift applies, and married couples can gift up to $38,000 per beneficiary. The 529 can also be “super-funded,” allowing a contribution of up to 5x the annual gift exclusion to a 529 plan ($95,000 for individuals and $190,000 for married couples). This could help avoid the gift tax liability and potentially reduce the size of your estate, for tax planning purposes. Changing the beneficiary of a 529 plan to a family member two or more generations below the current beneficiary may trigger Generation Skipping Transfer Tax (GSTT) so it is wise to consult with your tax advisor. However, changing a beneficiary to someone in the same generation or an older generation generally doesn't incur gift tax consequences.
With so many options, it can be helpful to enlist the help of a financial advisor who understands educational savings plans and tax savings to determine the best strategy going forward.