The tax advantages of college gifting

04/04/2014   
 

This content is provided courtesy of USAA.

Looking back on your life, you’re hopeful that the lives of your children and grandchildren will be better than your own. You’ve worked hard for years to provide for your family and to give them a bright future.

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As a grandparent, being able to help fund your grandchild’s education may be a real goal, but did you know college gifting might come with tax advantages, too?

Tax Tip: Federal law currently allows you to contribute up to $14,000 annually in total gifts per grandchild without triggering gift taxes. If you’re married and filing jointly, you and your spouse can double that amount and contribute $28,000 per child. For more information, please see IRS Publication 950.

Here are three ways to get started:

1. Chip in for college savings by opening a 529 college savings plan account for your grandchild in your name. Among the benefits:

  • Assets can be used at any eligible educational institution across the country and some schools abroad.
  • If your grandchild gets a scholarship or doesn’t attend college, any unused portion of your 529 account can be transferred to another child. There’s no time limit on when the funds can be used.
  • 529 funds have minimal impact on federal financial aid eligibility.
  • Contributions and money earned on the plan’s investments — whether through interest, dividends or capital gains — aren’t taxed if the beneficiary uses them to help pay for higher education. Depending on where you live, you also might get a tax deduction or tax credit on your state return for the contribution.

 

J.J. Montanaro, a Certified Financial Planner® professional with USAA, shares some additional thoughts regarding withdrawals. “If you need to use the money for something other than education, you can withdraw it, but it could cost you,” he says. “Withdrawals for reasons other than qualified education expenses will trigger taxes and a 10 percent IRS penalty on any earnings.”

One exception to the penalty is if your grandchild earns a scholarship. You may be able to withdraw assets up to the amount of the scholarship; while you’ll owe income tax on the earnings, you won’t have to pay the penalty.

“An accelerated 529 plan gift option allows you to front-load five years’ worth of the annual gift tax exclusion amount without incurring the federal gift tax,” says Caroline Tucker, product management director of the USAA 529 College Savings Plan. This means you can give up to $70,000 per beneficiary in a single year; married couples can contribute $140,000.

This option can be especially advantageous for those who wish to “power fund” the 529 plan. By contributing the annual gift tax exclusion amount near the end of one year, and then a front-loaded five-year contribution after January 1 of the next year, you can contribute $84,000 (or $168,000 for married couples) into a 529 plan within a matter of days.

“No other investment vehicle allows the power funding feature or avoids gift tax in this way,” says Tucker. “For grandparents, this is a unique feature that makes 529 plans so attractive and effective for saving on a tax-deferred basis.”

It’s important to note that giving any additional gifts to a grandchild during the five-year period will impact this strategy, and could be subject to the gift taxes or require filing additional tax forms. Contributions would also be subject to the add-back rule: If the donor dies within the next five years, a prorated amount would be added back to the estate.

2. Give shares of company stock, U.S. Series EE savings bonds or shares in a mutual fund.

To do so, open a custodial account through the Uniform Transfers to Minors Act, or UTMA, or the Uniform Gifts to Minors Act, known as the UGMA. This type of account is opened in your grandchild’s name, but you or one of the child’s parents control the assets until the child reaches adulthood. The assets are then relinquished to the child for use in any way he or she sees fit.

Caution: “If your grandchild is going to apply for financial aid, assets in his or her name — such as cash, stocks and bonds — must be reported on the Free Application for Federal Student Aid,” Montanaro warns. “Having more assets in the student’s name could reduce the amount of aid that is offered.” Families should consider this carefully when choosing how to save money for college.

3. Contribute to a Coverdell Education Savings Account.

Like 529 plans, Coverdell accounts are a potentially tax-free way to save for college. Unlike a 529, however, they can be used for kindergarten through 12th-grade expenses.

Caution: Only $2,000 can be contributed per year for any child. This limit includes contributions from all sources. If you were to put $2,000 into your grandchild’s Coverdell account in the same year that his parents or other grandparents make contributions, the annual limit would be exceeded. “Also know that as grandparents, you don’t control the funds you contribute. Most Coverdell accounts require the child’s parent or guardian to be in charge of the account,” adds Tucker.

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