Spoil Your
Grandkids, Save Tax Bills -- Another way to invest in life
Everyone should
start retirement planning no later than his or her first career job. Here comes
a new idea about investments. Apart from investing in your own retirement plan,
you might want to present your grandkids with a gift, which can help them
realize their dreams and brighten their future. It can deduct your tax bills as
well.
In this article,
it offers some of the tax-advantaged avenues available for older taxpayers who
wish to help pay for their grandkids' college costs.
When it comes
to paying for college, grandparents can also reap substantial tax benefits on
top of the enjoyment of watching their grandkids benefit from higher education.
Here is the
introduction of the 529 plans- Qualified Tuition Programs
College Savings Plan
College savings plans are
established by a state or eligible educational institution, and allow
individuals to make contributions in order to finance the beneficiary's
(student's) higher education. The contributions are made to a college savings
account and the balance in the account is determined by the performance of the
underlying investments. This ultimately affects the amount of funds available
to meet the beneficiary's eligible
education expenses.
Prepaid Tuition Plans
Prepaid tuition plans,
also known as prepaid education arrangements or prepaid tuition programs,
provide a way for families to beat the cost of inflation by purchasing
the future cost of tuition at today's rate. These plans are sold in units or by
contract, and cover a given number of years of tuition or a certain number of
credits. They are backed by the state and provide another low-risk alternative
for estate-conscious donors who wish to shift large amounts of assets to heirs
without reducing their unified credit. Drawbacks to these plans include
stiff withdrawal penalties and a
relatively low rate of return compared
to other options such as college savings plans. Furthermore, prepaid tuition
plans are generally only available for in-state residents and school alumni,
and may also be limited to in-state public institutions. Some plans do not
cover costs at private or out-of-state schools.
Limits
If used for qualified
education expenses, all contributions accumulate on a tax-deferred basis and
earnings are tax-free. Most states offer a tax deduction for residents who use
their state's plan, and a special tax break for wealthy taxpayers seeking to
reduce their taxable estates. Qualified tuition program rules stipulate that
contributors can stack up as many as five annual gift tax exclusions on top of each other in a single
year. For example, an individual could contribute up to $65,000 to a single
qualified tuition program in 2011 without creating any gift tax as long as the
money does not exceed the amount necessary for the child to complete their
higher education. Married couples can contribute twice that amount.
These limits are
applicable on a per-plan basis. So, couples seeking a tax-efficient transfer of
assets could contribute up to $130,000 to several different beneficiaries in a
single year. Furthermore, the beneficiary does not have to be a biological
grandchild. As a matter of fact, the beneficiary does not have
to be related to the contributor. An older couple with no children can even
choose to donate this amount to their neighbor's grandkids.
Drawbacks
The primary drawback
associated with qualified tuition programs is the penalty and taxation on the
earnings included in any plan distribution that is not used for qualified education
expenses. Nonqualified distributions are treated in the same way as early
distributions from a retirement plan or annuity; they're both assessed a 10%
early distribution penalty in addition to being counted as taxable income.
However, the income and penalty is assessed only on the earnings. Any tax or
penalty applies to the plan beneficiary and not to the contributor, which may
be a major factor for donors to consider.
U.S. Savings Bonds
Conservative investors can
find another education tax haven in bonds that are backed by the full faith and
credit of the U.S. government. The education bond program allows certain kinds
of bonds to be exempted from taxation if the proceeds are used to fund higher
education expenses. The interest generated from Series I bonds and EE bonds, zero-coupon bonds and STRIPS and Treasury
inflation protected securities
(TIPS), is eligible under this program, while Series H and HH bonds are not.
However, several conditions must be met in order for this exemption to apply.
Any eligible bond must have been issued after 1989 to an investor who was at
least 24 years old at the time of issuance.
If the bonds are to be
used to pay for a minor's higher education, the child must be the beneficiary
on the bonds and cannot own them directly. Furthermore, the child must be
claimed as a dependent on the parent's (or grandparent's) tax return. A single
investor - or $60,000 per couple - in a given year to qualify for the
exemption, can purchase no more than $30,000 of savings bonds. If these
conditions are met, savings bonds can provide a more flexible source of college
funding than 529 plans, as there is no penalty if the funds are used for a
different purpose. However, the interest on the bonds will then become taxable.
Coverdell Education
Savings Account
Originally created as
Education IRAs, these savings accounts were overhauled and expanded in 2002.
They allow for an annual nondeductible contribution of $2,000 for each child up
to the age of 18. The earnings grow tax-free, usually at the state and federal
levels, as long as the IRA is used for qualified education expenses.
However, the early distribution penalty and income tax are assessed on the
earnings portion of any amount remaining in the account for 30 days or more
after the beneficiary reaches age 30. The early distribution penalty does not
apply to exceptions such as the death or disability of the beneficiary.
The age 18 and age 30 limitations do not apply to beneficiaries with special
needs. (Learn about these accounts by touring our Education Savings Account Tutorial.)
Education savings accounts
differ from qualified tuition programs as contributions are aggregated per
child in the same manner as IRA contributions. Four different family members
cannot each make $2,000 contributions in the same year for the same
beneficiary. Furthermore, contributions are counted toward the gift tax
exclusion, which means that an individual who contributes $2,000 for tax year
2011 to these plans can only allocate another $10,000 as a nontaxable gift to a
qualified tuition program for the same beneficiary.
Withdrawals from these
accounts may also affect the taxpayer's ability to benefit from education tax
credits. While the beneficiary may be able to claim the credit in the same year
that the distribution is made from the education savings account, the
distribution and the credit cannot be used to cover the same expenses.
The disadvantages inherent
in these plans have made them much less popular than other avenues of saving,
such as the qualified tuition programs.
The Bottom Line
There are several options
for grandparents and other older taxpayers who want to reduce their income or
estate tax while helping young ones pay for college. However, taxation is only
one factor involved in choosing the right type of tuition assistance. Other
issues, such as who controls the assets, and coordination with financial aid,
must also be considered.
