If your clients are looking to help their grandchildren secure a better financial future, helping to cover college cost can be a great gift. Ensure your clients make the most out of their gifts by assisting them to make smart choices and taking advantage of potential tax savings relating to college costs. This recent article from SmartMoney.com discusses tax friendly ways to help pay for education costs.
3 Tax-Smart Ways to Pay Grandkid’s Tuition
May 30, 2012
1) 529 College Savings Account
529 college savings accounts allow contributions to grow free from federal taxes and allow federal tax-free withdrawals to cover qualified college expenses, as long as the basic requirements are met. Several states also offer tax incentives for 529 accounts.
Contributions made to a 529 account are considered gifts to the grandchild for estate tax purposes, and will reduce your client’s taxable estate. This means your client can contribute up to the annual gift exclusion amount of $13,000 in 2012 without any estate tax consequences. This $13,000 gift exclusion limit is per person, so if your clients are a married couple, they can make contributions of $13,000 each, allowing for a total contribution of $26,000 in a single year per grandchild.
If your clients are looking to make an even larger gift, you can let them know they can each make a onetime contribution of $65,000, for a total contribution of $130,000 per grandchild. “If you’re feeling really generous, you can make a larger lump-sum contribution to your grandchild’s Section 529 account and elect to spread it over five years for gift tax purposes. This allows you to immediately benefit from five years’ worth of annual gift tax exclusions while jump starting your grandchild’s college fund. You make the five-year spread election by filing IRS Form 709 (the federal gift tax return form).”
Even though 529 plans are not included in your clients estate for estate tax purposes, your client does retain control of the account and can decide on the amount of distributions. Your client would even have the ability to reclaim the funds in the account, although any withdrawals for non-qualified expenses are subject to tax and a 10% penalty.
2) Coverdell Education Savings Account (CESA)
Like 529 accounts, CESA allows for tax-free federal growth and withdrawals to pay for qualified education expenses. CESs are also known as an educational IRA.
CESAs are more limited than 529 plans in several ways. Contributions can only be made to grandchildren who are under 18 and the amount is limited to a total contribution of $2,000 a year per grandchild. Income restrictions apply, as discussed by the Smart Money article: “Here’s the catch: your right to make CESA contributions is phased out between modified adjusted gross income (MAGI) of $95,000 and $110,000 or between $190,000 and $220,000 if you’re a married joint filer. However, this restriction can often be circumvented by enlisting someone who is unaffected. For example, you can give the contribution dollars to your adult child (the parent of the grandchild in question), who can then open up the CESA as the “responsible person” and make a contribution on behalf of your grandchild. However, when the “responsible person” is someone other than yourself, your control over the account is lost. Keep that in mind.” CESAs have to be withdrawn for qualified education costs by the account beneficiary’s age of 30 or transferred to another family member to avoid penalties. CESAs become property of the beneficiary when he or she reaches 18, so your client would not be able to maintain control of the account like a 529 plan.
Some advantages of CESAs over 529 plans include the ability for the client to manage the investment of the funds (assuming they are the “responsible person”). 529 plans are limited to higher education, whereas CESA can be used for qualified education elementary and secondary school expenses. If your clients were interested in helping pay education costs for a non-family member, they can setup and fund a CESA for anyone under 18.
3) Pay Tuition Costs Directly to College
Your client can make gifts amounting to college tuition without any negative federal or estate tax consequences, as long as they pay the college directly. This provides the ability to lower your clients’ taxable estate, without affecting their federal gifting limit or estate tax exemption. This means your client could still use the annual federal gift amount to help pay for any education or non-education expenses. “If you wish, you can make additional gifts to your grandchild, up to the annual gift tax exclusion amount of $13,000, to help with other outlays like room and board, books, and transportation. If you’re married, the annual gift tax exclusion is effectively doubled to $26,000.”
These tips not only apply to grandparents, they can apply to any family member looking to help cover college expenses. College cost can be easily included in your clients’ financial plan using Silver or TOTAL Planning Suite. Both programs include a data input section to college cost, which can be used for dependent children or grandchildren. Silver, Easy Money and Golden Years financial planning reports include college funding, and the ability to include the cost of college in the retirement projections.