With the cost of higher education escalating yearly, planning for tuition and other educational costs can never begin too soon. As a grandparent, you want your grandchildren to go to a college or university. Moreover, you do not want them to be burdened by years of student debt that can derail or substantially delay future plans for children or the purchase of a home. Before you make a gift, you should consult with your advisors, including your attorney, financial advisor, and accountant, to ensure that you are achieving your objectives while maximizing tax benefits.
Here are some ways that grandparents can give a gift of education:
- Direct Gifts
The simplest way is to give a gift directly to your grandchild or fund a custodial account for the benefit of your grandchild. The problem with this method is that you have no control over use of the funds when they are released to the beneficiary, and therefore there is no guarantee that they will be used for educational purposes. Also, the funds are taxed at the parent’s rate if the child is under 14 or at the minor’s rate if older.
You can make annual gifts of $15,000 (or $30,000 if married) to any one individual without triggering the need to file a gift tax return.
You could also open a mutual fund account or purchase certain bonds (Series E or EE, or municipal), but there is always an element of risk in such investments.
- Section 529 Plans
An excellent alternative to direct gifts is to establish a Section 529 Plan. You set up an account with a beneficiary and may make unlimited contributions to it, although anything over $15,000 per year, per beneficiary may be subject to the federal gift tax and requires that you file a gift tax return. But you can fund it all at once with 5 years’ of contributions at $15,000 per person, per beneficiary (or double if married) and not trigger the Federal gift tax. In other words, an individual may
contribute five years worth of gifts all at once, or $75,000 per beneficiary per donor, without triggering the Federal gift tax, and a couple can gift $150,000.
Under Wisconsin law, the first $3,140 per donee is eligible for gross income exclusion, meaning it is not counted as taxable income.
If you use 529 account withdrawals for qualified higher education expenses, earnings in the 529 account are not subject to federal income tax and, in most cases, state income tax. There is a 10% penalty in addition to the normal tax rate if the funds are withdrawn for any use other than qualified higher education expenses. Further, none of the funds in the plan will be considered to be part of the grandparent’s estate.
There are no tax consequences if you change the designated beneficiary to another member of the family. Also, any funds distributed from a 529 plan are not taxable if rolled over to another plan for the benefit of the same beneficiary or for the benefit of a member of the beneficiary’s family. So, for example, you can roll funds from the 529 for one of your children into a sibling’s plan without penalty.
Trusts can also be used as tools to fund a grandchild’s education. If you have multiple grandchildren, then you will need to consider whether to have one educational trust for each grandchild or have an aggregate Grandchildren’s Trust. Gifts to a grandchildren’s trust, however, are not generally considered a “gift of present interest.” This means that the donee does not have an immediate right to the use of the gift, so that the gift exclusion of $15,000 does not apply. Certain trusts, however, can be created which will allow for the annual exclusion.
For example, you can set up a 2503(c) trust that does allow for the annual gift exclusion so long as the beneficiary of the trust is under 21. A 2503(c) trust has these traits:
• The principal and income is to be used only for the benefit of the beneficiary before the minor reaches the age of 21
• All accumulated income and principal is to be made available to the minor at the age of 21
• If the minor dies before the age of 21, the trust assets must be payable to the minor’s estate or pursuant to the minor’s general power of appointment
• The trustee is to have unfettered authority to distribute the trust funds to the minor and is not limited to distributions for a particular purpose (such as illness, disability, or education)
• Trust assets are all available to the minor when he or she reaches age 21. The requirement of the trust assets being made available to the beneficiary when he or she reaches age 21 is satisfied where the beneficiary has the right, during a limited period of time (i.e., 30 days after attaining the age of 21) to demand trust property by giving written notice to the trustee. If the beneficiary does not withdraw all the funds, then the trust terms continue, and the trust does not terminate until the beneficiary reaches a certain designated age.
• The trust has a contingent beneficiary in the event the minor passes away before the age of 21
• The trust income is taxed to the beneficiary to the extent of the distribution
• Trust funds are not part of the donor’s estate
• All funds must go towards tuition–any balance when the trust is terminated must go to a charitable beneficiary
• To the extent the trust income is retained by the trust, it is taxable to the trust. Trusts have compressed rates and income will be subject to higher rates than individuals at the same level of income.
The major advantage of a 2503(c) Trust is that it qualifies for the annual exclusion. However, leaving funds in the trust subjects those funds to rates that are higher than those for individuals making the same income.
To ensure the exclusion of trust assets from the donor’s estate, the trustee of an education trust should be an independent trustee.
To maximize investment performance, the trustee, independently or along with a financial advisor, should manage the trust assets.
Call the Schloemer Law Firm
Planning for your grandchildren’s future is fun but serious, and you want to ensure that your financial gifts for their future educational needs are secure and not subject to unnecessary taxation or waste. Talk to an attorney from Schloemer Law Firm who can help you set up a mechanism for giving the gift of education to your loved ones.
Disclaimer: The information contained in this post is for general informational purposes only and is not legal advice. Due to the rapidly changing nature of law, Schloemer Law Firm makes no warranty or guarantee concerning the accuracy or completeness of this content. You should consult with an attorney to review the current status of the law and how it applies to your unique circumstances before deciding to take—or refrain from taking—any action. If you need legal guidance, please contact us at 262-334-3471 or [email protected]