It’s always a good time to start saving for your child’s college tuition. No matter how old your child is, your family can benefit from strategies designed to pay for college in tax-efficient ways.
Below, Ferguson Timar’s knowledgeable team discusses a few tax-efficient tuition strategies worth considering. Reach out to our office directly for personalized guidance about which may best serve your family’s broader financial goals. Together, we’ll maximize your child’s college fund while minimizing your tax liability.
Sponsored by states or educational facilities and terminated at any time, 529 accounts facilitate flexible savings. Deposits made to these accounts qualify for the federal gift tax exclusion that resets every year, while account investment growth is income tax-deferred. As long as you use the accounts savings for qualified higher-education tuition and related expenses, the account balance will be treated as income tax exempt. In addition, some states offer an income tax deduction or credit at the state level for contributions to 529 plans.
Unlike the custodial accounts discussed below, 529 accounts are technically owned by a child’s parent or grandparent. The owner, not the child, remains in control over account distributions even after the child reaches the age of 21. Many families benefit from the ability to transfer funds out of these accounts between multiple children or grandchildren.
Finally, suppose a parent or grandparent wishes to make a particularly large investment in a 529 account. In this case, they can claim up to five years’ worth of annual exclusion gifts—not subject to federal gift taxes—in a single payment. Parents or grandparents interested in making even more significant contributions at one time should speak with our team about setting up an irrevocable trust to maximize investment flexibility while minimizing tax liability.
A custodial account may be created for a minor child under the Uniform Transfers to Minors Act (UTMA) in every state except South Carolina. (Parents in South Carolina wishing to open a custodial account must follow the rules set by the Uniform Gifts to Minors Act (UGMA)). A UTMA/UGMA account custodian controls savings and distributions. Once the child reaches an age specified by state law—somewhere between 18 and 25 years—the then-adult beneficiary will take over control of the account.
The custodian of a UTMA/UGMA account is frequently a trusted loved one other than a parent or grandparent. This approach allows a child’s parents and grandparents to make deposits into the account that qualify for the federal gift tax exclusion annually. As the child beneficiary of the account is its owner, any account earnings will not affect the income tax of those loved ones gifting deposits into the account.
Gift Tax Exemptions for Direct Payment
If your child or grandchild is graduating from high school and you don’t have time to save for college, you can take advantage of a gift tax tuition loophole right now. Money isn’t subject to gift tax liability when tuition payments are made directly to an institution of higher learning.
To qualify for this gift tax exemption, you must pay the school directly. If the money is given to the student, that money won’t be classified as a “direct payment of tuition” and will be subject to ordinary gift tax rules. Also, college expenses other than tuition—including room, board, and various fees—aren’t eligible for this gift tax exemption.
Tax-Efficient Tuition Guidance Is Available
Ferguson Timar’s tax-strategy experts will assist you with paying for college in tax-efficient ways. Whether your child is a toddler, or your high school graduate is soon moving on to college, we’re ready to provide your family with personalized, professional guidance.
To begin constructing a tax-efficient tuition fund strategy, connect with our team via email or give us a call at (714) 204-0100. We look forward to speaking with you.