Typically one has to have a college education these days to be able to provide for the basics in life. The cost of education is on the rise, so starting a college savings plan early in your child’s or grandchild’s life may make all the difference in your ability to pursue your funding goals. Using federal grants, work-study or loans if your child or grandchild is eligible for student aid may also help as you strive to reach your goals. At Placer Summit Financial Group we help clients plan to save for some portion or all of the cost of a child's education. The following is a general overview of the different types of accounts you can use to save for education:
529 Plans: 1) Contributions are not tax deductible, but grow free from federal income tax as long as distributions are used to pay for qualified expenses. If funds are not used for qualified expenses, federal income taxes and penalties may apply; 2) The amount that can be deposited to 529 plans can be substantial, in some plans over $300,000 per beneficiary. No income limits apply to donors and there are no age restrictions on the beneficiary; 3) 529 plans are used frequently for estate planning purposes where donors seek to get a large sum out of their estate to manage estate taxes owed on their death. Special rules apply to 529 plans and allow gifting of up to five times the annual gift tax exclusion limit provided donors make the proper election on their tax returns; 4) Some states offer income tax deductions for contributions and/or exemption from state income taxes for withdrawals; 5) Donors retain control over the investment strategy and withdrawals. In most cases donors also have complete control over account beneficiary changes and can remove one child in favor of another qualifying family member; 6) In most plans, unless a beneficiary has been changed to a qualifying family member, the investment strategy for the account can be changed only twice every calendar year.
Prior to investing in a 529 Plan investors should consider whether the investor's or designated beneficiary's home state offers any state tax or other benefits that are only available for investments in such state's qualified tuition program.
Coverdell Education Savings Accounts: 1) Contributions are not tax deductible, but grow free from federal income tax as long as distributions are used to pay for the account beneficiary's education costs; this type of account can be used for certain expenses involving elementary school, secondary school, and college, vocational or other eligible post secondary schools. If funds are not used for education related expenses, federal income taxes and penalties may apply; 2) The total contribution for a beneficiary cannot exceed $2,000 in any year, but that amount is phased out for high income families; 3) Account balances must be distributed by the time the account beneficiary is age 30 or earnings will be taxed and subject to a penalty. These taxes and penalties may be avoided by rolling over the amount in the account to an eligible family member.
Uniform Transfer to Minors Act Accounts: 1) These accounts provide a mechanism for irrevocable gifts to be made to minors without the need for a court appointment of a guardian or conservator or the establishment of a trust; 2) Contributions are subject to federal annual gift tax exclusion limit; 3) No income tax limits exist and anyone can establish an account for the benefit of a minor; 4) Income taxes on dividends, interest, and capital gains are paid by the minor at their rate until certain income thresholds are met at which time the minor's parent's income tax bracket applies; 5) The custodian for the account is typically a child's parent who manages and invests the account's assets until the child reaches a certain age. The age custodianship typically terminates is 18, but in some states is 21, and under certain circumstances can be 25; 6) After the age of termination, the custodian is required to transfer the account assets to the beneficiary and the account beneficiary acquires exclusive control over them. The beneficiary can then do anything they want with the assets, which could be contrary to the donor's intent.
Accounts in your name: 1) If you maintain an account in your own name for the benefit of your child or your children's education you also maintain absolute control over the assets; 2) You have complete flexibility with how you invest the assets, and can invest any amount that you choose; 3) If a child does not attend college, you retain your assets and can do anything with them; 4) There are no income tax benefits for saving for education in an account that you maintain in your own name - federal and state income tax is due annually as interest, dividends or capital gains are experienced.
Content in this material is for general information only and is not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
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