As the academic year winds down and high school students shop for prom dresses and rent tuxes, parents, grandparents, aunts and uncles often think about planning for the college education of their beloved little (and not so little) ones. We are often asked to advise clients about the various techniques for making gifts to help with the staggering costs of higher education.
Tax-favored 529 accounts are one popular option. Named after Internal Revenue Code Section 529, no income tax is reportable on the appreciation within the account as long as no withdrawals are made. When withdrawals are used for qualified college education expenses, including vocational school expenses, the withdrawals are not subject to income tax. It is possible to front load these accounts by making a deposit of five times the annual exclusion (currently $14,000) and electing to treat the gift as made proportionately over five years. Each state has its own 529 account product. New Hampshire's version of the 529 account is called the UNIQUE college investment plan, sold through Fidelity. You do not have to choose a 529 account established by an institution in your state of residence. The primary disadvantage to these accounts is that if the proceeds are not used for qualified college education expenses by the time the beneficiary is 30, when the funds must come out, then a 10% penalty applies in addition to the income tax on the appreciation of the assets. It is possible to change the beneficiary to someone under age 30, who will use the funds for college expenses. If you are uncertain whether a beneficiary will go to college, these accounts are not ideal. Websites that compare the various 529 plans include: savingforcollege.com and collegesavings.org.
Custodial accounts are an old favorite and still offer a reasonable choice for college savings. These accounts may be set up at any financial institution and are in the child's name and social security number with an adult custodian designated to be in control of the account until the child reaches the age of 21. The interest earned on the account is taxable currently. The purposes for which the funds can be used, however, are not limited to college education. It is not advisable to put more into a custodial account than is likely to be used for college. Any balance in the account when the child reaches age 21 must be turned over to the child.
Irrevocable Trusts offer the most flexible option, because they can be drafted to provide that the funds can be used for educational expenses including private elementary and secondary school as well as for other purposes such as to help a beneficiary with a down payment on a house or to help a beneficiary with starting a business. Irrevocable Trusts can continue for an extended period of time, until the age at which the donor thinks the beneficiary would be ready to receive the remaining principal outright. One disadvantage to setting up and funding an Irrevocable Trust is that the Trustee will be required to file an income tax return each year in which the Trust has any taxable income or gross income greater than $600. There are also legal fees associated with the creation of Irrevocable Trusts.
Perhaps the simplest approach is for a family member to make the tuition payment directly to the college or university. Gifts of tuition paid directly to the educational institution do not have any gift tax consequences to the donor. Such payments do not apply against the $14,000 annual exclusion for gifts. For a very generous family member, it is possible to pay a child's $40,000 college tuition bill and give the child $14,000, without any gift tax consequences.
While the best planning is done closer to the first day of kindergarten than the night of the prom, it is never too late. Many alternatives are available if you would like to make a gift to help support a child's education. Call the office if you would like to schedule an appointment to discuss which of these options is best suited to your individual circumstances.