Financial planning strategies for higher education costs

Paying for a college education is one of the most significant financial investments that many families will make. Planning can feel overwhelming, given the uncertainty around future costs and the ever–changing nature of federal student loan regulations. Understanding all the various avenues for financing higher education is the first step to developing a well–structured financial plan, because this allows families to evaluate their choices, make informed decisions, and allocate resources most effectively.

Education savings accounts

Savings accounts for educational expenses are among the most commonly used tools for preparing for upcoming higher education costs. A variety of options are available, beyond a traditional savings account. Education savings plans, such as 529 plans and Coverdell education savings accounts, are favorable options due to the tax advantages they provide. Sec. 530A Trump accounts should be considered as well.

529 plans

529 savings plans are state–sponsored college savings plans that allow tax–free growth on contributions and tax–free withdrawals if earnings are spent on qualified educational expenses. Once a 529 account is open, anyone can make after–tax contributions. While there is no annual contribution limit, each state generally sets a lifetime contribution limit per beneficiary (ranging from $300,000 to $600,000, based on estimated future educational costs). The money is then invested into state–specific investment portfolios. As long as the money remains in the account, no income tax is paid on the earnings. When money is later withdrawn from the account, it is tax free when used for qualified expenses. Qualified expenses generally include tuition; fees; books; equipment (including computers); and room and board for students enrolled at least half–time in a program at an eligible college (including off–campus housing costs, but they generally cannot exceed the school’s cost–of–attendance allowance for room and board). If not used for qualified expenses, earnings on the withdrawals are considered taxable income to the person who received the distribution (and may also result in a 10% penalty). Although 529 plan accounts are included as a parental asset on the Free Application for Federal Student Aid (FAFSA), which can reduce financial aid eligibility, 529 plans owned by a grandparent or other nonparent relative are usually not counted as an asset on the FAFSA.

A second, lesser–known type of plan under Sec. 529 is the prepaid tuition plan. While states are permitted to offer both types of Sec. 529 plans, only a limited number of states offer prepaid tuition plans. A prepaid tuition plan allows families to lock in tuition at certain public in–state colleges at the current rate, protecting against future tuition increases. Generally, either the account owner or the beneficiary must be a resident of the state sponsoring the plan.

Coverdell, custodial, and Trump accounts

Another instrument for education savings is a Coverdell education savings account (Coverdell ESA). Like a 529 plan, it offers tax–free distributions used for qualified educational expenses. One advantage over a 529 plan is that there is often a more diverse selection of investment options for a Coverdell ESA. However, contributions are limited to $2,000 per year per beneficiary for couples with a modified adjusted gross income (MAGI) of up to $190,000 ($95,000 for single filers). The contribution limit is reduced for joint filers with an MAGI of $190,000 to $220,000 and single filers with an MAGI of $95,000 to $110,000. Joint filers with an MAGI of $220,000 or more are ineligible to contribute ($110,000 or more for single filers).

An alternative option to education savings plans families may also want to consider is a custodial account. Although these are not specifically designed for education, they are a commonly used tool in education planning. These savings accounts are managed by the custodian (typically, a parent or grandparent) on behalf of a minor until they reach the legal adult age. Once they are of age, the beneficiary gains control of the account and can use the funds for any purpose. Unlike the previously discussed education plans, there are no restrictions on how the funds can be spent, as long as the money benefits the beneficiary. There are also no income or contribution limits. Further, contributors can take advantage of the annual gift tax exclusion to fund the account. Two frequently used types of custodial accounts are Uniform Gifts to Minors Act accounts or Uniform Transfers to Minors Act accounts.

The primary disadvantage of a custodial account is the taxation (“kiddie tax”) of investment income. While the first $1,350, inclusive of any other of the child’s unearned income, is generally not taxed, the next $1,350 is taxable at the child’s marginal tax rate. Any earnings over $2,700 are taxed at the parent’s marginal rate if the kiddie tax applies. Taxes are not deferred and must be paid in the year in which the income was earned. Custodial accounts are considered a student–owned asset on the FAFSA and may affect financial aid eligibility.

Trump accounts were introduced with the passage of the law commonly known as the One Big Beautiful Bill Act (OBBBA), H.R. 1, P.L. 119–21. Also referred to as a Sec. 530A account, a Trump account is a new type of traditional IRA that parents, guardians, adult siblings, or grandparents may establish on behalf of children under age 18, using IRS Form 4547, Trump Account Election(s). Contributions are capped at $5,000 per year per child (indexed for inflation starting in 2028) and can be made by anyone, including parents, family, friends, employers, charitable organizations, and the child. Individual contributions generally are made with after–tax dollars and are not deductible. However, employer contributions made under a qualifying program may be excluded from the employee’s income.

Children born between Jan. 1, 2025, and Dec. 31, 2028, are eligible to receive a $1,000 government pilot program contribution to deposit into the account. This pilot program contribution money does not count toward the $5,000 annual contribution limit. Contributions must be invested in assets permitted under Sec. 530A(b)(3), which include eligible U.S. stock market index funds or exchange–traded funds. Funds are generally not accessible until the calendar year in which the child turns 18. Thereafter, the account is treated as a traditional IRA, with similar taxation of earnings and penalties for early withdrawals but with notable exceptions, including that beneficiaries are allowed to withdraw funds from the account penalty–free to pay for higher education and other specified purposes.

Financial aid and scholarships

Financial aid and scholarships represent important resources for reducing the overall cost of higher education. Numerous forms of assistance are available through federal and state governments, educational institutions, and private organizations. Best of all, grants and scholarships are free to students, with no repayment required, and are generally not considered taxable income. Students should begin by completing the FAFSA. The form collects financial information about the student and, in most cases, the parents. The information is then used to determine the student’s financial need and eligibility for a multitude of financial aid, loan, and scholarship programs.

Financial aid can be awarded at the federal, state, or institutional level. In addition to federal loans (discussed below), the U.S. Department of Education provides financial aid in the form of grants and work–study programs. Federal aid is generally distributed based on financial need, with the Pell Grant being the most common. Amounts vary by student, with a maximum amount of $7,395 for the 2025–2026 academic year. Federal work–study programs can offset education costs by offering on–campus part–time employment opportunities for students.

Programs vary by state, can be in the form of a grant or scholarship, and may be merit– or need–based. For instance, Georgia and Tennessee each have separate state–funded, merit–based HOPE (Helping Outstanding Pupils Educationally) Scholarship programs. In addition, another program in Tennessee, the Tennessee Student Assistance Award, is based on financial need. Several other states offer similar scholarships. Many colleges extend financial aid at the institutional level as well. Unlike the federal and state programs, funding comes from the school through alumni donations, endowments, fundraising, etc. Most schools award institutional funds based on need and/or merit. Like federal financial aid, need is based on the student’s and their family’s finances. Merit can be measured by a variety of factors, including academics, athletics, musical abilities, leadership, extracurricular activities, and other talents and achievements.

Outside scholarships offered by private organizations provide an additional source of gift aid for students. Eligibility criteria for these scholarships vary considerably and may include a student’s intended field of study, demographic background, academic achievement, community involvement, leadership experience, financial need, or even the demonstration of perseverance and resilience. Students can use a search database, such as Scholarships.com and College Board Scholarship Search, to identify these scholarship opportunities.

An emerging trend among some colleges and universities is to offer free tuition to certain accepted students, extending significant savings to students and families. Elite universities such as the Massachusetts Institute of Technology (MIT), Yale, and Harvard boast free tuition to accepted students based on generous need–based thresholds; for instance, under MIT’s financial aid policy,undergraduates with family income below $200,000 can attend tuition–free, and families with income below $100,000 can expect to pay nothing toward the full cost of attendance. Some public universities such as those of North Carolina (UNC), Michigan, and California provide free tuition to accepted students based on both need and residence; for instance, UNC–Chapel Hill covers tuition and mandatory fees for qualifying in–state undergraduates whose family income is below $80,000.

Debt financing

Debt financing can also be used to cover higher education expenses. A variety of borrowing options are available to students and families, including both federal and private student loan programs designed to help bridge funding gaps. Loans offered through the federal government are in most cases the more favorable borrowing choice. Their advantages include fixed interest rates; borrower protections (i.e., deferment and forbearance options); income–based repayment plans; and potential loan forgiveness.

Most federal loans do not require a credit check or a cosigner, with the exception of Direct PLUS loans, which include Parent PLUS loans and Grad PLUS loans. The eligibility criteria are relatively straightforward. An applicant must be a U.S. citizen (or eligible noncitizen); have a high school diploma (or equivalent); be enrolled at least half time in an eligible program; and maintain satisfactory academic progress (grade point average, course completion rate, and ability to finish the degree within a maximum allowed time frame). There are no income limits for federal student loans, but financial information provided on the FAFSA, along with cost of attendance and other aid the student is receiving, is used by a school in determining the amount and type of the loans (subsidized or unsubsidized) for which the student is eligible.

Annual and lifetime borrowing caps apply. Under the OBBBA, significant changes to these limitations went into effect in July 2026. The new borrowing caps are designed to discourage students and families from assuming debt exceeding their ability to repay. For more information on this topic, refer to Cokeley and Bentley, “How Tighter Student Loan Caps Will Affect Higher Education,” Journal of Accountancy (June 1, 2026).

Beyond the decision to borrow, repayment plans and loan forgiveness are key factors when considering debt financing. Borrowers have traditionally used one of several federally sponsored income–driven repayment plans. Under these plans, monthly payments are calculated as a percentage of income. These payments are recalculated each year based on changes in income and family size. At the end of the repayment period, any remaining balance is forgiven. The OBBBA significantly restructured and simplified the repayment plan framework by creating the Repayment Assistance Plan (RAP) as well as the Tiered Standard Repayment Plan, while eliminating eligibility for some existing repayment plans. Since July 1, 2026, new and existing borrowers may select the RAP or the Tiered Standard Repayment Plan. However, by July 1, 2028, other currently available options (Saving on a Valuable Education (SAVE), Pay As You Earn (PAYE), or Income–Contingent Repayment (ICR)) will be eliminated. Borrowers with loans from before July 1, 2026, that are enrolled in SAVE, PAYE, and ICR must transition to an eligible repayment plan by July 1, 2028. New borrowers may then select only from RAP or the Tiered Standard Repayment Plan.

A key distinction between the two new plans is that RAP is an income–driven repayment plan that forgives any remaining balance after 30 years of qualifying payments, while the Tiered Standard Repayment Plan bases monthly payments on the amount borrowed and applicable repayment term. Because a Tiered Standard Repayment Plan loan is designed to be fully amortized over that term, no balance remains to be forgiven at the end of repayment.

Student loan forgiveness programs have been a focus of debate among policymakers in recent years. Although the Biden administration attempted to broadly forgive student debt under the Higher Education Relief Opportunities for Students (HEROES) Act, P.L. 108–76, that initiative was blocked by the Supreme Court (Biden v. Nebraska, 600 U.S. 477 (2023)).

The Public Service Loan Forgiveness (PSLF) program remains active. Under the PSLF, full–time employees of a federal, state, local, or tribal government or (most) not–for–profit organizations may qualify to have the remaining balance of their Direct Loans forgiven after making the equivalent of 120 monthly payments under a qualifying repayment plan. The Department of Education recently issued final regulations to narrow the types of organizations a person who is seeking loan forgiveness under the PSLF program can work for, by excluding organizations that have a “substantial illegal purpose,” including supporting terrorism or aiding and abetting illegal immigration, among other things. These regulations are being challenged in the courts.

Individuals employed as teachers or medical professionals may also be eligible for various other debt forgiveness programs through service in qualifying low–income educational settings or certain medical positions. Teachers may benefit from the federal Teacher Loan Forgiveness program after teaching full time for five consecutive years at a qualifying low–income school, while medical professionals may benefit from limited loan repayment assistance after just two years of service with the National Health Service Corps. Several other service or repayment programs exist for teachers and medical professionals that benefit underserved or disadvantaged populations.

Under specific circumstances, provisions for the discharge of federal student loans exist. In the event of the total and permanent disability of a qualifying student loan borrower, federal student loans may be discharged. Under borrower defense to repayment, student loans may be discharged in the event of misconduct by the educational institution, such as false advertising, misrepresentation of graduates’ earnings or job placement rates, or other deceptive or illegal recruiting and enrollment practices.

Tax exclusions, credits, and deductions

Tax exclusions, credits, and deductions while a student is in school or during repayment can also play a significant role in managing the financial burden associated with higher education. Notably, a scholarship or grant received is generally excluded from taxable income for students who are candidates for a degree at an eligible educational institution if the scholarship does not exceed qualified educational expenses; is not earmarked for other purposes; and does not represent payment for teaching, research, or other services required as a condition for receiving it.

Several Internal Revenue Code provisions provide financial relief to students and families paying qualified educational expenses. Two of the most valuable tax benefits are the American opportunity tax credit (AOTC) and the lifetime learning credit (LLC). The AOTC is capped at $2,500 per student per year for qualifying educational expenses for the first four years of post–secondary education. Unlike the AOTC, the LLC can be claimed for an unlimited number of years. It applies to educational expenses related to undergraduate, graduate, or professional degrees (e.g., medical or law school), as well as courses to improve job skills or to maintain professional licensure. However, the maximum credit is $2,000 per return (not per student). To prevent “double dipping” on the same expenses, a taxpayer cannot claim the AOTC and LLC for the same student in the same year.

Additionally, the student loan interest deduction allows up to $2,500 of interest paid on education loans to be deducted from gross income each year. The deduction phases out for taxpayers filing single if their MAGI is between $85,000 and $100,000 ($170,000 to $200,000 for taxpayers filing a joint return).

An array of strategies

Financing higher education may require multifaceted planning and strategy, including education savings plans, student loans, scholarships, and other financial aid. Being aware of all possible funding options, as well as tax exclusions, credits, and deductions, is critical. Strategic planning and informed decision–making can significantly reduce the financial stress associated with paying for a college education.

Contributors

Ashley Bentley, CPA, Ed.D., and Emily D. Cokeley, CPA, Ph.D., are both assistant professors of accountancy at East Tennessee State University in Johnson City, Tenn. For more information about this column, contact thetaxadviser@aicpa.org.