Richard English, J.D., Managing Director, Commerce Family Office, Kansas City
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Key Takeaways
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Ensuring a child can experience the education you envision for them may be one of the most meaningful goals a parent, grandparent, or other family member can achieve. Determining the most effective way to pay for tuition and higher education expenses requires careful planning. For high-net-worth families, evaluating strategies to fund a child’s education can be more complex, as they often involve navigating gift tax rules, utilizing available tax exclusions, and ensuring the child’s responsible use of funds. And, if you are in a position to plan for the goal of continued funding should you unexpectedly pass away, a contingency funding plan is another component to build into your overall education strategy.
Each funding strategy comes with its own advantages depending on your time horizon, tax objectives, and desired level of control. Vehicles such as 529 plans, UGMA or UTMA accounts, or trusts may offer long-term growth potential for invested assets. In contrast, making tuition payments or seeking scholarships can satisfy a more direct need for funds. You may even consider making an intrafamily loan to provide the child with more favorable borrowing terms.
529 plans and accelerated gifting
A 529 plan is a tax-advantaged investment account that allows assets to grow tax-free with no taxes owed on withdrawals used for qualified education expenses. Typically, a parent or grandparent opens and funds the 529 account through a state-sponsored plan and names their chosen beneficiary. The account owner retains full control over the account and the assets within it, even after the beneficiary reaches adulthood, and can change the beneficiary or withdraw funds at any time. Withdrawn funds can be paid to the school directly or transferred to the student.
With a 529 plan, parents and/or grandparents can each contribute up to five times the annual gift tax exclusion amount ($95,000 in 2025) in a single year without triggering a taxable gift1. This strategy is referred to as “accelerated gifting” because the IRS can treat a lump-sum contribution to a 529 plan as if it were spread out over five years.
In practice, accelerated gifting could allow two parents to give a maximum of $190,000 to the 529 account, which can be invested and withdrawn tax-free when used for qualified education expenses. Each grandparent can also contribute up to $95,000 to a 529 account for their grandchild under this rule, allowing multiple family members to make significant contributions and potentially lower their federal estate taxes by reducing the value of their taxable estate. However, if the contributor passes away within five years of making an accelerated gift to a 529 plan, a prorated portion of the gift will be added back into their estate for estate tax purposes.
If the 529 account is overfunded and tuition and education expenses are less than expected, the account owner has several options to put the excess funds to good use. The account owner can change the beneficiary to another qualifying family member without penalty, allowing the surplus funds to be repurposed for another child’s education. Alternatively, if the account has been open for at least 15 years and other qualifying conditions are met, up to $35,000 can be rolled over into a Roth IRA in the name of the beneficiary of the 529 plan. The account owner could also withdraw the excess for non-qualified purposes. In this case, the investment gains will be subject to federal income tax and will incur a 10% withdrawal penalty.
Recent changes to the Free Application for Federal Student Aid (FAFSA) mean that distributions from 529 plans are no longer treated as student income or affect financial aid eligibility, so long as the plan is owned by someone other than the student’s parent, such as a grandparent, aunt, or uncle.
Because 529 plans are governed at the state level, plan rules, investment options, and tax benefits may vary. In many states, funds can also be used for K-12 private school tuition as well as other qualified higher education expenses. Some states limit the total contributions allowed per beneficiary. While contributions are not deductible for federal income tax purposes, some states offer a state income tax deduction or credit to help lower state income tax liability.
Direct payments and the unlimited exclusion for tuition expenses
Directly paying for tuition may be the most straightforward way to fund a child’s higher education expenses. The unlimited exclusion for tuition expenses allows high-net-worth families to make a gift without worrying about whether the gifted amount falls within their annual gift tax exclusion. This makes it possible to give additional gifts to the same recipient during the year without triggering a taxable gift.
To qualify for the unlimited exclusion for tuition expenses, tuition must be paid directly to a qualifying educational organization on behalf of the student. Other expenses, such as books, supplies, and housing, do not qualify for the unlimited exclusion. If you decide to help pay for other expenses directly, take care not to exceed the annual gift tax exclusion amount ($19,000 for individuals and $38,000 for gifts from married couples), or you may use some of your lifetime exemption or incur unexpected gift taxes. If you are concerned about exposure to federal estate taxes, using the unlimited exclusion to pay for tuition expenses may ultimately lower a future estate tax liability and preserve both your annual exclusion and lifetime exemption to transfer other assets in a tax-efficient manner.
Note that directly paying for tuition or other expenses means missing out on the potential tax-free growth offered by 529 plans. Direct payments may make sense if your time horizon is shorter and funds are required for near-term education expenses, where investing the funds for potential long-term growth may not be practical. Relying on direct payments could leave a funding gap if the donor unexpectedly passes away. It will be important to build in a contingency funding plan for monies that would have been paid directly. Setting aside assets in a trust for this purpose is one way to ensure continued support for a beneficiary’s education.
Leveraging trusts for tuition and other education expenses
You can also create a trust either for the sole purpose of funding education or to meet a broader set of needs for the beneficiaries. The specific benefits and considerations will depend on the type of trust and the provisions included in the trust’s governing document. A trust can be structured to allow distributions for health, education, maintenance, and support. Provisions of this nature can give trustees the discretion to cover education-related expenses while providing for a beneficiary’s broader financial needs.
In terms of the timing of distributions, a trust can be structured at your discretion to distribute funds at set intervals or upon specific life milestones, such as reaching a certain age or starting a first job. A trust used to fund education can also help you reduce estate tax exposure, provide asset protection for beneficiaries, or address concerns related to a beneficiary’s spending habits. Importantly, a trust can continue to operate even after you pass away, allowing beneficiaries to receive ongoing support according to your direction.
Trusts offer a high degree of customization and can be tailored to support a family member’s needs beyond just education. If you already have an established trust, consider whether it permits education-related distributions, and if not, whether creating a trust for this purpose may be appropriate.
UGMA and UTMA accounts
Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) accounts are custodial accounts that allow the adult account owner to manage the account with the intention of a minor assuming account ownership upon reaching a certain age and are governed by state law. These accounts offer greater flexibility for the child, as funds can cover a broader range of expenses than a 529 plan. For parents and grandparents, however, this could be a drawback, as they have no control over how and when the funds are spent once the child assumes ownership of the account.
Both UGMA and UTMA accounts are taxable accounts that share many similarities, but the key difference between the two is that UGMA accounts can only be funded with financial assets such as cash and securities. Whereas UTMA accounts2 can be funded with a wider variety of assets, such as real estate, intellectual property, or other physical property, such as art and collectibles.
When parents or other family members fund an UGMA or UTMA account, the assets can be invested for potential growth, and the child takes control of the account once they reach the age of majority. The age of majority differs from state to state, but is typically between 18 and 25. Once a gift is made to a UGMA or UTMA account, the donor cannot reclaim the assets, and the beneficiary is free to use the assets for any purpose upon reaching the age of majority.
Funding UGMA and UTMA accounts can provide estate tax benefits by lowering the donor’s taxable estate through irrevocable gifts. However, custodial accounts offer no control over the use of assets once ownership transfers and may lead to unintended tax consequences due to a lack of tax advantages.
Applying for scholarships
Pursuing scholarships may encourage your child to take initiative and ownership in the funding of their education, a value many families aim to instill in the next generation. Strong academic, athletic, or talent-based performance can open the door to merit-based awards while reinforcing the value of studying and working hard toward the meaningful long-term life goals of pursuing excellence and becoming independent. Scholarship availability and award amounts can vary significantly across educational institutions and are often determined by each student’s unique qualifications and circumstances.
Scholarships typically fall under two categories: merit-based scholarships and need-based scholarships. Merit-based scholarships are awarded based on merit criteria such as academic achievement or athletic ability. Need-based scholarships are awarded primarily based on financial need. For students from high-net-worth families, their parents’ income and assets typically disqualify them from need-based financial aid.
Students from high-net-worth families may still find it necessary to fill out the Free Application for Federal Student Aid (FAFSA). The FAFSA can be a requirement for securing a merit-based scholarship. Your child may also need to submit the College Scholarship Service (CSS) Profile or provide additional information through their chosen college’s scholarship portal, depending on the institution’s requirements for merit-based aid.
Making an intrafamily loan
If you expect your child to share some financial responsibility for their education, an intrafamily loan may provide more favorable borrowing terms and a lower interest rate for your child than traditional student loans. If offering an intrafamily loan, care must be taken to ensure the IRS does not consider the loan a gift for tax purposes. Otherwise, the loan could count against your lifetime estate and gift tax exemption or trigger gift taxes if your exemptions are already exhausted.
The IRS requires a signed written agreement between you and your child in order to treat the transfer as a loan rather than a gift. The terms should include the loan term, a fixed repayment schedule, and the interest rate. The interest rate must be at least the minimum applicable federal rate (AFR), which is set and updated by the IRS each month. The AFR is typically lower than the interest rate on a federal or private student loan, which can help your child save on total borrowing costs over the life of the loan.
If the loan is forgiven, the unpaid balance will be considered a gift by the IRS. In addition, you, as the lender, may be required to report interest received as taxable income.
An intrafamily loan can be a practical solution when your child understands your goals for them, and expectations for making timely payments are clearly communicated. When structured properly and the terms of the loan are followed, an intrafamily loan can help your child take ownership of their education while providing them with a more affordable interest rate.
Craft a holistic plan to pay for education with professional guidance
When helping fund a child or grandchild’s education, it is important to weigh the advantages of different funding options against potential tax consequences for gifts, the impact on your cash flow if making direct payments, and the level of control you think is necessary to ensure funds are used for education expenses as intended.
At Commerce Trust, your private wealth management team regularly advises high-net-worth families on understanding the complexities of funding strategies to help ensure your contributions are optimized and aligned with your objectives. Your team is comprised of specialists in education planning, investment strategy, tax management*, and estate planning who can help you understand the potential impact of various education funding strategies in the context of your family’s broader wealth management goals. Whether you want to better understand the tax implications of each strategy, navigate using a trust for education funding, or learn how complementary funding strategies can work together, our team can provide coordinated guidance backed by deep experience across multiple disciplines.
Contact Commerce Trust today to learn more about how we can help you support the next generation of your family’s education in a way that aligns with your values and long-term goals.
1 Gifts over the annual gift tax exclusion ($19,000 in 2025) are considered taxable gifts that use a portion of the donor’s lifetime estate and gift tax exemption or are subject to a top tax rate of 40% if the lifetime exemption has already been exhausted. Taxable gifts also require filing Form 709, the United States Gift (and Generation-Skipping Transfer) Tax Return.
2 UTMA accounts are not allowed in Vermont and South Carolina.
*Commerce does not provide tax advice to customers unless engaged to do so.
The opinions and other information in the commentary are provided as of September 5, 2025. This summary is intended to provide general information only and may be of value to the reader and audience.
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