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 $32,000 ($16,000 for a single person) using the annual gift tax exemption in 2022. 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 $16,000 for individuals ($32,000 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 2022 allows you to give $16,000 as an individual (or $32,000 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
If you have questions about these, please schedule an appointment. Having successfully used 529 plans, I do have personal experience on how it worked with my own kids.
Courtesy of Fresh Finance.