Education planning or college funding planning refers to the following topics: 529 Pla~s, tax credits for education expenses, investment planning for education costs, and tax deductions or tax favorable treatment related to education expenses. To do education planning correctly requires a good knowledge of income tax planning. To set up an asset allocation for a 529 Plan requires special effort since changes inside the 529 account are allowed only once a year. Investment allocations need to be balanced between a need for the higher returns from stocks on one hand contrasted on the other hand with the fact that a tax-free vehicle is best used for bonds, so it may be better to keep stocks out of a 529 Plan. Also the risk of a stock market crash hurting your child’s education budget are serious, so that is another reason to consider bonds for the allocation. To have plenty of time to recuperate from a stock market crash one should have a minimum of ten years, preferably 17 years, and since many 529 Plan participants will be spending the funds in a decade then there is significant risk that stocks in a 529 Plan could result in a lower return than bonds. Further complicating the allocation decision is that many 529 Plans have limited choices of expensive funds, so that implies it is best to use a state plan that has a cheap bond index fund and use the 529 Plan as a place to fulfill the “global” (big picture) bond allocation. This means when funds are spent from the 529 Plan that the client would need to re-allocate more of his other funds into bonds, assuming the goal was to maintain the same proportion of bonds. 529 Plans require documentation that college expenses are legitimate and busy, immature students may not want to verify and document petty purchases, so it maybe best to limit 529 Plan spending to a few large, easily documented expenses.

College funding planning relates to integrated financial planning, the 529 Plan future contributions should be examined to see how it effects estate planning. This is because contributions are subject to the annual $14,000 tax-free gift limit and it may be best for high net worth clients to refuse to give funds to a 529 Plan and instead give each year $14,000 of FLP units or “Crummey ILIT Trusts” to their heirs. Anyone can gift funds for tuition without gift tax if they write the check payable directly to the college, instead of to a 529 Plan.

For those who own small businesses and who can employ their children in the business there are some tax advantaged ways to pay for college using college funding planning. However, these must be offered to all employees, so if too many non-family employees want to go to college then it might be unwise to offer this program.

Hidden Traps in Tax Law

Donald Martin is a NAPFA-Registered Fee-Only financial planner and investment advisor.