Forward Bank
4 Tax Advantaged College Funding Strategies
August 14, 2024
You know the old adage, "Nothing in life is certain but death and taxes." Add to that a third certainty: college education costs will continue to outpace inflation. Ouch.
There are numerous tax-efficient strategies that could help fund your child's or grandchild's college education while at the same time reducing your taxes now (and the taxes your beneficiaries owe later when transferring wealth). Here are four college funding strategies that may be appropriate for your situation:
1. 529 Plans
Contributions to a 529 education savings plan are considered gifts, and a married couple can gift up to $36,000 ($18,000 for a single person) using the annual gift tax exemption in 2024. 529 plans allow you to pull forward up to five consecutive years' worth of annual gift tax exemptions into a single calendar year. Also, you can pull forward annual gift tax exemptions every five years as part of your wealth transfer plan. (Before implementing this strategy, be sure you understand how using 529 plans may impact your future tax liability.)
2. UTMAs
The UTMA (Uniform Transfer to Minor Act) is a custodial account set up by a parent or grandparent with the child as beneficiary and the parent as the custodian. Once assets like cash or stocks are gifted into the child's UTMA, the assets move out of your estate and reduce your taxable estate. The UTMA gift goes towards your annual gift tax exemption of $18,000 for individuals ($36,000 for married couples) and deducts from your lifetime gift and estate tax exemption.
One thing to be aware of is that UTMA accounts are viewed as assets belonging to the student (rather than parents), so UTMAs with significant balances may limit the student's eligibility for financial aid. The federal financial aid formula expects students to contribute 20% of savings, versus a maximum of 5.6% of savings for the parents.
3. Custodial Roth IRAs
If your child or grandchild is working and has income, a parent or grandparent can contribute (up to the child's income) to a custodial Roth IRA during that calendar year. A parent or other adult must open the Roth IRA account and become the account's custodian until the child is 18.
4. Cash
The annual gift tax exclusion in 2024 allows you to give $18,000 as an individual (or $36,000 as a married couple) in cash or other assets each year, tax-free, to help fund your child's or grandchild's college education. Also, while limiting your tax liability, you can pay directly to their higher-education institution.
Understanding the lifetime exemption
The IRS allows a lifetime tax exemption on gifts and estates, up to a specific limit, adjusted yearly to keep pace with inflation. The Tax Cuts and Jobs Act of 2017 (TCJA) created a significant opportunity to tax-efficiently transfer wealth to the next generation and beyond. The exclusion amount for 2024 is $13.61 million for an individual and $27.22 million for a married couple (and is subject to further adjustment for inflation through 2025). For those desiring to make the significant gift of a college education, the lifetime exemption is an opportunity to transfer wealth to younger generations at a much-reduced transfer tax cost.
Give our office a call to discuss your goals for funding a college savings account. We're here to help you make the best decisions about providing this wonderful gift to your child or grandchild.
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The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced courtesy of Fresh Finance.