Saving and Paying for Education Costs

There are well established tax benefits available for most individuals and extended families saving for or currently paying education costs. While most apply to higher education and the largest benefits reduce state taxes, acting early and strategic planning can have a material impact on post tax wealth.

This note addresses only 1 of 11 possible benefits at the federal level which reduce income taxes and enable tax free compounding of investment. A multi-linear strategy would consider all of these benefits together and we'll address the other benefits individually and holistically in future papers.

TLDR - If you plan to pay for the cost of higher education for anyone in your family, a 529B strategy implemented to day could reduce the amount you must save or invest by 10-20% . Let us do the work and create a plan for you

Background

529 Plans are more formally called Qualified tuition programs (QTP's). The "529" part comes from the section of the US tax code that allows them. Without going into the detail of the code: 

• contributors to this program may be able to reduce their taxable income at the State level up to a certain amount 
• cash contributions can be invested and capital gains are not taxed as long as...
• Beneficiaries use distributions for qualified educational expenses.

A very valuable part of the program is that the contributor can change the designated beneficiary over the years with no real restrictions. So establishing an investment and retaining these tax benefits and earning compounding gains can be very lucrative for the extended family or multi-generationally.

• Son, daughter, stepchild, foster child, adopted child, or a descendant of any of them. 
• Brother, sister, stepbrother, or stepsister. 
• Father or mother or ancestor of either
• Stepfather or stepmother. 
• Son or daughter of a brother or sister. 
• Brother or sister of father or mother
• Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law. 
• The spouse of any individual listed above. 
• First cousin. 

What are qualified education expenses? Qualified elementary, secondary or higher education tuition and "required" expenses, or expenses that are unavoidable for attending a program.

Tax Benefits

Example 1

In 2022, our client who earns 250k/year & lives in NY opens a 529 Account in their own name and contributes 10k every year for 10y years, invested in an index which returns 7%. The client also receives a 10k deduction on NY state taxes each year and at the 6.85% local and state taxes bracket, they reduce their tax burden by 685 dollars and chose to invest this in the same 7% index fund outside of the plan.

Here's a comparison of post tax returns vs a traditional investment approach: The present value of this strategy over 20 years is worth about 15k (2)

Constructing a Strategy

Within your financial plan today, in order to incorporate these benefits into an investment strategy, you need to answer a few questions that matter:

1. Will you pay for higher education costs for yourself or immediate family in the next 20 years
2. If you dont have children now, do you ever want to start a family and pay for your childrens education at any level?
3. If not your own children, do you have nephews or nieces or extended family who may spend money on education?
4. If any of the above are true
   1. What exact year do you think you will need to begin spending on education
   2. What states do you and your extended family live?

With these answered, one can extract value for generations.

For People who Care

The code allows for a State or educational institutions (1) to establish a "program" within which a person can buy tuition credits on behalf of, or make contributions to meet qualified education expenses for, a designated beneficiary. Both the contributor and the beneficiary get tax benefits by reducing their taxable income by the contribution, excluding the distribution from taxable income and not paying taxes on capital gains within the program.

(1) Generally agencies of the state are also allowed to set these programs up, but it is not relevant to the strategy

(2) Using a discount rate of 7% (the return on investment in this scenario) and