American Expat Financial Planning: Using 529 Plans to Save For College
By Peggy Creveling, CFA and Chad Creveling, CFA
This article is for general information purposes only and is not intended as specific tax advice. Please consult your tax advisor for advice relevant to your situation.
If you're an American expat with kids who one day plan to attend college or university, you've probably read or heard about how quickly the cost of higher education has been rising. Recent figures bear this out; according to the latest survey by The College Board, the average published tuition and fee price of a full-time year at a U.S. public four-year institution was 40% higher, after adjusting for inflation, in school year 2015-16 than it was in 2005-06. For the most recent academic year, all-in total costs (tuition, books and supplies, room and board, and transportation) averaged $38,544 per year at four-year public colleges for out-of-state students, $47,831 per year for private universities, and over $65,000 for some Ivy League schools.
Rising college expenses aren't limited to the U.S.; tuition costs for international students in other English-speaking countries have also been rising quickly, in part as cuts in public funding take their toll.
529 Plans to the Rescue
But all is not lost. Beyond your child winning as many funding grants as possible, taking on debt, and the possibility of receiving a major athletic or academic scholarship, there is an additional way that American expat parents can help lower the burden of saving for college. Back in 1996, Congress created a way to save for college that provides similar tax benefits as the Roth IRA provides for retirement savings.
This savings vehicle is the “qualified tuition 529 plan,” or “529 plan” for short. By contributing to a 529 plan, the earnings on your contributions can build up on a U.S. tax-deferred basis. Furthermore, if the funds are later used for qualifying college costs (tuition, fees, books, supplies, and room and board), the earnings are U.S. tax-free. Not only can funds from 529 plans be used at any accredited university in the U.S., but they can also be used for qualifying international schools.
How Significant Are the Tax Savings? A Comparative Example
How much you can save on U.S. tax will depend on how early you start saving for your child's education, your U.S. tax rate, how much you contribute to the 529 plan, and how well markets do. However, to give you an idea of the value of the potential tax savings, consider the following example:
Joe and Sue are American parents living overseas with a combined income of $300,000, including salary, bonuses, housing allowances, and school fees. They file U.S. taxes using the "married filing jointly" status, and are in the 33% marginal tax bracket. They've just had their first child, and are planning to save and invest each year in a moderately allocated diversified portfolio for their child's planned four-year college education beginning in 2034 at Harvard University (total current cost per year: $61,659).
Assuming that U.S. capital gains taxes remain 15% per year for their income level, that average historic returns are achieved, and that they start saving now, Joe and Sue will need to save and invest about $14,500 per year in current USD in order to have a good chance of paying for their child's future education. However, if they instead begin contributing to a similarly allocated 529 plan, their savings will go further. Effectively, by making the savings contributions to a 529 plan, they'll be able to reduce their savings by an aggregate of over $103,000 (or $4,000 per year in current dollars)―and still pay for Harvard―simply due to the U.S. tax savings nature of the 529 plan.
Choosing a 529 Plan
If contributing to a 529 plan to save for your children's college makes sense to you, the next step is selecting which 529 plan to open an account with. As an expatriate who is not a resident in a specific U.S. state, you will not receive a state income tax deduction for your contributions. This means that instead of being limited to just one state's plan, you're free to select the best option among all the 50 states. At first glance, the choice can be daunting. Each one of the U.S. states has at least one 529 plan option, and many have several. To make a good selection, look for the plan with the following attributes:
- Low expenses—seek plans that offer passively managed funds and low administration fees.
- A variety of investment options to choose from.
- An "age-based option," which means the plan will automatically adjust its asset allocation to be less volatile as your child approaches college age.
To help narrow the choice among the 529 plans available, check out the following websites, which offer screen tools and other useful information:
Yes, savings in 529 plans can be used to pay for qualified expenses at many international or non-U.S. institutions. For the 2016–17 school year, there are 409 international (non-U.S.) schools that are eligible. Details on which international institutions qualify can be found on the Federal Student Aid website: www.fafsa.ed.gov/.
Some Other Considerations:
- Distributions from 529 plans are only free of U.S. tax if they are used to pay for qualified college expenses (tuition and fees, books and supplies, room and board).
- You can contribute up to $14,000 (2016) per year per child (or $28,000 for both parents) without gift tax consequences.
- Alternatively, you may contribute up to $70,000 in one year (or $140,000 for both parents) and count that contribution for the next five years ($14,000/year x 5 years = $70,000 for a single filer, or x 2 for couples filing jointly = $140,000).
- Who owns the 529 plan (parent, grandparent, or student) may to some degree affect a student's ability to qualify for U.S. federal financial aid.
- In general, 529 plans should have the parents listed as the account holders and the children as the beneficiaries. This allows the parents to make changes to the accounts as needed.
- If you are a non-U.S. resident, your country of residence may not recognize the tax-free status of 529 plans.
- You'll want to be careful not to over-contribute to a 529 plan, as nonqualified withdrawals (where the funds are not used for qualified college expenses) will incur a 10% penalty plus tax on the earnings portion of the distribution.
- If it does become apparent that a 529 plan contains more than is needed for one child's college, rather than making unqualified withdrawals and paying a penalty, you could shift some of the funds to a plan for another child, or you could leave funds in the plan indefinitely and name a new beneficiary at a later point (perhaps a grandchild).
Saving for a child's college education can be a major task for American expats. However, getting started early in putting aside regular savings in a U.S. tax-advantaged vehicle such as a 529 plan can help put you ahead of the game.
This article is a revised, updated reversion of articles that have appeared previously on www.crevelingandcreveling.com