Funding Education: Know Your Options | Northern Trust Funding Education: Know Your Options | Northern Trust
Skip to content

Funding Education: Know Your Options

Share

Share this article on FacebookShare this article on XShare this article on LinkedinShare this article via EmailPrint this article

Supporting the goals and dreams of future generations is important work and deserves a thoughtful planning process.

Planning for the education of a child is an important goal for many families, but finding the right solution can be complex. Time horizon, type of education and family circumstances all play a role in defining the right approach. Saving for pre-school requires a different strategy than saving for college or graduate school, and planning options vary in terms of flexibility, contribution limits, tax benefits and more.

The following summary of potential tax benefits and long-term savings options can help make the planning process less daunting. It will also equip you to have better conversations with your tax, financial and legal advisors, who can help you put a plan in action. 

Tax Benefits

Before considering specific funding strategies, it is important to understand the following three potential tax benefits of paying for education more broadly. This includes considering the federal and state gift and generation-skipping transfer (GST) tax consequences, as summarized below:

1

The Annual Gift Tax Exclusion

The annual federal gift tax exclusion for 2024 allows a family to give a single beneficiary $18,000 ($36,000 per married couple) per year without incurring any gift or GST tax liability. The beneficiary can use this money to cover education or non-education expenses.

Key Consideration:

If your gift is made to a trust, ensure that the trust is designed to qualify for the annual gift tax and, if applicable, GST exclusions.

2

Direct Tuition Payments

Direct tuition payments to elementary, secondary, post-secondary or other qualifying schools are not subject to gift tax. The exclusion for direct tuition payments is available regardless of the relationship between the donor and the student, but the exclusion is limited to tuition only and does not extend to books, room and board, and other expenses.

3

Income Tax Credits

State and federal governments also offer education income tax credits. At the federal level, there are two credits: the Lifetime Learning Credit and the American Opportunity Tax Credit. Taxpayers can only claim one of the credits.

Key Consideration:

Evaluate whether the student should file an independent tax return in order to claim a credit. An education tax credit is available only to students who are not claimed as a dependent on someone else’s tax return. Under 2017 tax law, parents generally claimed students as dependents. Under current tax law, the personal exemption has been suspended, so there may be more incentive for students to file independently.

 

Federal Education Income Tax Credits

Type of Education Income Limitations* Amount of Credit LIFETIME LEARNING CREDIT $2,000 per tax return. $2,500 per student per year. All years of post-secondary education and for courses to acquire or improve job skills (including non-degree programs). Four-year college. $180,000 if married filing jointly; $90,000 for single filers. $180,000 if married filing jointly; $90,000 for single filers. *Income numbers refer to "modified adjusted gross income," which often is the same as "adjusted gross income" or "AGI." AMERICAN OPPORTUNITY TAX CREDIT
Type of Education Income Limitations* Amount of Credit LIFETIME LEARNING CREDIT $2,000 per tax return. $2,500 per student per year. All years of post-secondary education and for courses to acquire or improve job skills (including non-degree programs). Four-year college. $180,000 if married filing jointly; $90,000 for single filers. $180,000 if married filing jointly; $90,000 for single filers. *Income numbers refer to "modified adjusted gross income," which often is the same as "adjusted gross income" or "AGI." AMERICAN OPPORTUNITY TAX CREDIT
LIFETIME LEARNING CREDIT AMERICAN OPPORTUNITY TAX CREDIT Amount of Credit Amount of Credit Type of Education Type of Education Income Limitations* Income Limitations* $2,000 per tax return. $2,500 per student per year. All years of post-secondary education and for courses to acquire or improve job skills (including non-degree programs). Four-year college. $180,000 if married filing jointly; $90,000 for single filers. $180,000 if married filing jointly; $90,000 for single filers. *Income numbers refer to "modified adjusted gross income," which often is the same as "adjusted gross income" or "AGI."

Long-Term Savings Plans:

According to the College Board, the average cost of tuition at a private, four-year institution for the 2023-2024 school year was $41,540. If you factor in room and board, books, and other expenses, this amount balloons to more than $60,000 annually.1

Fortunately, there are a number of savings plans to help you pay these significant costs. They vary in terms of contribution limits, qualified expenses, tax treatment and other features, as summarized below:

Long-Term Savings Options

Funding Funding Income Restrictions Income Restrictions Qualified Expenses Qualified Expenses Tax on Earnings Tax on Earnings Ability to Ability to Change Beneficiary Change Beneficiary Federal Gift Federal Gift Tax Treatment Tax Treatment Investment Investment Contribution Limits Contribution Limits 2503(C) MINORS TRUST HEALTH AND EDUCATION EXCLUSION TRUST (HEET)* No limit. No limit. Provides a broader definition of permissible Tuition payments made directly to the school are the only permitted education expenses. Can also make direct payments for health care. educational expenses and related costs. Earnings are taxable. Grantor trust tax rules may apply. Earnings are taxable. Subject to gift tax. Annual exclusion does not apply. Yes, but only if the trust terms allow. Not limited to a single beneficiary. Terms of the trust will define what the class of beneficiaries is and whether it can be changed. Transfers are treated as completed gifts; may use annual gift tax exclusion. Cash or property. Cash or property. No. No. Funding Income Restrictions Qualified Expenses Tax on Earnings Ability to Change Beneficiary Federal Gift Tax Treatment Investment Contribution Limits UTMA No limit. No restrictions. May be used for purposes other than education. Kiddie tax rules apply. No. Represents an irrevocable gift to the child. Transfers are treated as completed gifts; may use annual gift tax exclusion. Cash or property. No. Funding Income Restrictions Qualified Expenses Tax on Earnings Ability to Change Beneficiary Federal Gift Tax Treatment Investment Contribution Limits ABLE ACCOUNT* The annual gift tax exclusion amount ($18,000 in 2024). Through 2025, ABLE account beneficiaries with compensation income can contribute the lesser of (a) the beneficiary’s compensation for the tax year, or (b) the federal poverty line amount for a one-person household in the prior year ($14,580 for 2024). Education, housing, transportation, employment training and support, and other expenses that improve health independence and/or quality of life. Earnings are tax-free if used for qualifying expenses. Yes, but change will be most tax efficient if new beneficiary is a “member of the family” of the old beneficiary and an individual who meets the disability definition. Contributions treated as completed gift; may use annual gift tax exclusion. Cash only. Only for beneficiary’s excess contributions. Funding Income Restrictions Qualified Expenses Tax on Earnings Ability to Change Beneficiary Federal Gift Tax Treatment Investment Contribution Limits 529 PLAN Established on a plan-by-plan basis; some plan account balance limits may be as high as $500,000. Includes K-12 tuition along with qualifying higher educational expenses, such as: books, computers and related equipment, and room and board at eligible colleges and universities. State tax treatment may vary. Earnings are tax-free if used for qualifying expenses. Distributions are tax-free when used for qualifying education expenses. Yes, but change will be most tax efficient if new beneficiary is a “member of the family” of previous beneficiary, occupying the same generation as the previous beneficiary. Contributions treated as completed gift; may use annual gift tax exclusion. May frontload up to five years. Cash only. There is an income tax deduction for contributions in some states. No. *To avoid GST tax, HEET trusts typically need to name a charitable beneficiary as well as grandchildren or more remote descendants as beneficiaries. It can make unlimited tuition payments on behalf of any number of descendants, potentially in perpetuity, and it can be funded during life or at death. *ABLE accounts are only available for individuals with a disability.
Funding Funding Income Restrictions Income Restrictions Qualified Expenses Qualified Expenses Tax on Earnings Tax on Earnings Ability to Ability to Change Beneficiary Change Beneficiary Federal Gift Federal Gift Tax Treatment Tax Treatment Investment Investment Contribution Limits Contribution Limits 2503(C) MINORS TRUST HEALTH AND EDUCATION EXCLUSION TRUST (HEET)* No limit. No limit. Provides a broader definition of permissible Tuition payments made directly to the school are the only permitted education expenses. Can also make direct payments for health care. educational expenses and related costs. Earnings are taxable. Grantor trust tax rules may apply. Earnings are taxable. Yes, but only if the trust terms allow. Not limited to a single beneficiary. Terms of the trust will define what the class of beneficiaries is and whether it can be changed. Transfers are treated as completed gifts; may use Subject to gift tax. Annual exclusion does not apply. annual gift tax exclusion. Cash or property. Cash or property. No. No. Funding Income Restrictions Qualified Expenses Tax on Earnings Ability to Change Beneficiary Federal Gift Tax Treatment Investment Contribution Limits UTMA No limit. No restrictions. May be used for purposes other than education. Kiddie tax rules apply. No. Represents an irrevocable gift to the child. Transfers are treated as completed gifts; may use annual gift tax exclusion. Cash or property. No. *ABLE accounts are only available for individuals with a disability. Funding Income Restrictions Qualified Expenses Tax on Earnings Ability to Change Beneficiary Federal Gift Tax Treatment Investment Contribution Limits ABLE ACCOUNT* Education, housing, transportation, employment training and support, and other expenses that improve health independence and/or quality of life. Earnings are tax-free if used for qualifying expenses. Yes, but change will be most tax efficient if new beneficiary is a “member of the family” of the old beneficiary and an individual who meets the disability definition. Contributions treated as completed gift; may use annual gift tax exclusion. Cash only. Only for beneficiary’s excess contributions. Funding Income Restrictions Qualified Expenses Tax on Earnings Ability to Change Beneficiary Federal Gift Tax Treatment Investment Contribution Limits 529 PLAN Established on a plan-by-plan basis; some plan account balance limits may be as high as $500,000. Includes K-12 tuition along with qualifying higher educational expenses, such as: books, computers and related equipment, and room and board at eligible colleges and universities. State tax treatment may vary. Earnings are tax-free if used for qualifying expenses. Distributions are tax-free when used for qualifying education expenses. Yes, but change will be most tax efficient if new beneficiary is a “member of the family” of previous beneficiary, occupying the same generation as the previous beneficiary. Contributions treated as completed gift; may use annual gift tax exclusion. May frontload up to five years. Cash only. There is an income tax deduction for contributions in some states. No. *To avoid GST tax, HEET trusts typically need to name a charitable beneficiary as well as grandchildren or more remote descendants as beneficiaries. It can make unlimited tuition payments on behalf of any number of descendants, potentially in perpetuity, and it can be funded during life or at death. The annual gift tax exclusion amount ($18,000 in 2024). Through 2025, ABLE account beneficiaries with compensation income can contribute the lesser of (a) the beneficiary’s compensation for the tax year, or (b) the federal poverty line amount for a one-person household in the prior year ($14,580 for 2024).
Funding Funding Income Restrictions Income Restrictions Qualified Expenses Qualified Expenses Tax on Earnings Tax on Earnings Ability to Change Beneficiary Ability to Change Beneficiary Federal Gift Tax Treatment Federal Gift Tax Treatment Investment Contribution Limits Investment Contribution Limits 2503(C) MINORS TRUST HEALTH AND EDUCATION EXCLUSION TRUST (HEET)* No limit. No limit. Provides a broader definition of permissible educational expenses and related costs. Tuition payments made directly to the school are the only permitted education expenses.  Can also make direct payments for health care. Earnings are taxable. Grantor trust tax rules may apply. Earnings are taxable. Yes, but only if the trust terms allow. Not limited to a single beneficiary. Terms of the trust will define what the class of beneficiaries is and whether it can be changed. Transfers are treated as completed gifts; may use annual gift tax exclusion. Subject to gift tax. Annual exclusion does not apply. Cash or property. Cash or property. No. No. Funding Income Restrictions Qualified Expenses Tax on Earnings Ability to Change Beneficiary Federal Gift Tax Treatment Investment Contribution Limits UTMA No limit. No restrictions. May be used for purposes other than education. Kiddie tax rules apply. No. Represents an irrevocable gift to the child. Transfers are treated as completed gifts; may use annual gift tax exclusion. Cash or property. No. Funding Income Restrictions Qualified Expenses Tax on Earnings Ability to Change Beneficiary Federal Gift Tax Treatment Investment Contribution Limits ABLE ACCOUNT* The annual gift tax exclusion amount ($18,000 in 2024). Through 2025, ABLE account beneficiaries with compensation income can contribute the lesser of (a) the beneficiary’s compensation for the tax year, or (b) the federal poverty line amount for a one-person household in the prior year ($14,580 for 2024). Education, housing, transportation, employment training and support, and other expenses that improve health independence and/or quality of life. Earnings are tax-free if used for qualifying expenses. Yes, but change will be most tax efficient if new beneficiary is a “member of the family” of the old beneficiary and an individual who meets the disability definition. Contributions treated as completed gift; may use annual gift tax exclusion. Cash only. Only for beneficiary’s excess contributions. Funding Income Restrictions Qualified Expenses Tax on Earnings Ability to Change Beneficiary Federal Gift Tax Treatment Investment Contribution Limits 529 PLAN Established on a plan-by- plan basis; some plan account balance limits may be as high as $500,000. Includes K-12 tuition along with qualifying higher educational expenses, such as: books, computers and related equipment, and room and board at eligible colleges and universities. State tax treatment may vary. Earnings are tax-free if used for qualifying expenses. Distributions are tax-free when used for qualifying education expenses. Yes, but change will be most tax efficient if new beneficiary is a “member of the family” of previous beneficiary, occupying the same generation as the previous beneficiary. Contributions treated as completed gift; may use annual gift tax exclusion. May frontload up to five years. Cash only. There is an income tax deduction for contributions in some states. No. *To avoid GST tax, HEET trusts typically need to name a charitable beneficiary as well as grandchildren or more remote descendants as beneficiaries. It can make unlimited tuition payments on behalf of any number of descendants, potentially in perpetuity, and it can be funded during life or at death. *ABLE accounts are only available for individuals with a disability.

Key Consideration:

The 2017 Tax Cuts and Jobs Act (Tax Act) expanded 529 plan rules to include qualified elementary and secondary education tuition expenses. But consult your advisors before taking advantage of this change, as there is a $10,000 annual cap on distributions for K-12 education,2 and state-level rules and limitations may apply.

While the above overview provides a good starting point, in practice, picking the best funding solution is highly dependent on a myriad of variables unique to your family’s needs. Work with your advisors to identify these needs, align them with a strategy and execute a plan. Future generations will thank you.

Funding Education

Execute Your Plan

Explore funding solutions to support your family's future.

THE NORTHERN TRUST INSTITUTE

Proven Advice for Moments that Matter

Learn More
On Purpose

Subscribe for Our Insights

Sign up to receive our On Purpose publication to help you achieve your financial goals as intended.

Tags

TaxesPersonal finance
  1. https://research.collegeboard.org/trends/college-pricing/highlights
  2. Distributions in excess of $10,000 are subject to federal and state income tax on the earnings portion of the withdrawal, plus an additional 10% federal penalty. Other state income tax issues may be present (e.g., recapture of a previous income tax deduction as income if distribution is used for K-12 tuition); consult your applicable state plan and with your tax advisor.

Disclosures

This information is not intended to be and should not be treated as legal, investment, accounting or tax advice and is for informational purposes only. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal, accounting or tax advice from their own counsel.  All information discussed herein is current only as of the date appearing in this material and is subject to change at any time without notice.

Related Articles

  • Check
    Navigate to Plan for the Future of Your Art Collection
    The Art of Collecting

    Plan for the Future of Your Art Collection

    Understand the financial implications of transferring your collection to family or charity.

  • Check
    Navigate to Engaging the Rising Generation
    Money Masterclass

    Engaging the Rising Generation

    Prepare future family leaders for success.

  • Check
    Navigate to Money and the Mind
    Money Masterclass

    Money and the Mind

    Stan Treger is using psychology to help others understand “the why” behind their money story.

  • Check
    Navigate to College-Bound Planning: Key Financial and Health Care Decisions
    Money Masterclass

    College-Bound Planning: Key Financial and Health Care Decisions

    Understand key financial and healthcare planning decisions for families of college-bound students.

Explore Specialized Advice

    Slide 1 of 5
  • Check
    Navigate to Business Owner

    Business Owner

  • Check
    Navigate to Executive

    Executive

  • Check
    Navigate to Multigenerational Families

    Multigenerational Families

  • Check
    Navigate to Elevating Women

    Elevating Women

  • Check
    Navigate to Family Offices

    Family Offices