Beyond the basics: Strategies for college savings
Gifting and other strategies can save taxes and offer flexibility in covering costs.
Saving for college is a major priority for many families. Despite escalating costs of a four-year degree causing some to question the cost relative to the payoff, most of our clients view a four-year degree as the minimum expectation for their children. While many can afford the college of their child’s choice, most still want to be smart about how they save and pay for college.
One thing is certain: it makes sense to save early and often. Average annual costs for tuition, fees, and room and board for 2014–15, according to collegeboard.org, were: $42,400 for private four-year schools, $19,000 for public in-state students, and $32,800 for public out-of-state students. Many elite or Ivy League colleges cost more than $60,000 per year.
Most families set aside funds to pay for college either through 529 savings plans (tax-advantaged plans that can be used to pay for qualified higher education expenses) or custodial accounts (savings or investment accounts registered in the child’s name with a parent or other adult as custodian).
Some parents may cover 100% of college expenses. Others may ask their student to contribute through part-time employment. Some grandparents or other relatives are also able or willing to help.
It’s important for parents to answer key questions to help determine their goal. Are you absolutely sure your child will attend a four-year college or university, or is a two-year or technical college a possibility? Perhaps your child is headed for an advanced degree such as in medicine or law, which also could affect your decisions.
For many affluent families, gifting directly to the student can provide flexibility and financial advantages to parents and other contributors and/or the students, depending on individual circumstances. Unlike 529 college savings plans, there is no financial penalty in withdrawing the funds if the student later chooses not to attend college, or does not need all of the money that was put aside.
There are significant advantages to using gifts of cash or stock to help pay for a child’s college education, but it’s best to consult a tax professional before taking any action to make sure you understand the tax implications.
Gifts of cash
A parent may give a child up to $14,000 per year (or $28,000 for a couple) without being subject to the federal gift tax. The same rule applies for grandparents or other relatives, and 529 plans offer some unique gift benefits. In any year in which a gift contribution for a beneficiary exceeds the annual gift limits, the gift may be spread over five years. That allows for front-loading of up to $70,000 (or $140,000 for a couple) without being subject to the gift tax. No other gifts to the beneficiary may be made during those five years to qualify for this treatment.
A parent or grandparent may also directly pay the college or university to cover the child’s costs without being subject to the annual limit on gifts. However, tuition paid by a grandparent or anyone other than the parent would be reported as income to the child and might affect the child’s financial eligibility for programs or scholarships based on financial need.
Gifts of stock
Another way to contribute to a child’s college costs is to transfer shares of stock or mutual funds to the child. While this transfer or gift of shares will count toward the gift tax exclusion, the main benefit is in avoiding capital gains taxes and resetting the cost basis. If the stock or fund was purchased long ago and has a significant increase in value, transferring it to the child resets the cost basis to the date of the gift. The stock now belongs to the child at its current value, the parent (or other gift giver) does not owe capital gains tax and the stock’s value can continue to increase until the child needs it for college expenses. By gifting the investment instead of cashing it in, the parent “saves” the 15% capital gains tax that would otherwise be due if the investment were sold.
Gifts of stock are subject to the same $14,000/$28,000 annual limits as cash gifts. For example, if a couple gives stock worth $100,000 to a child, they would need to report $72,000 on the child’s tax return which would count against their estate tax exclusion of $5.43 million per person or $10.86 million per couple.
For some children who have enough income to be self-supporting due to significant gifts, these children may be able to claim themselves on their own tax return and potentially even claim the American Opportunity Tax Credit. The caveat is that a child who claims him or herself as a dependent cannot be claimed on a parent’s tax return. Consult a tax advisor to determine who should claim the student.
Roth IRA option
A parent who wants to save for retirement can use a Roth account and then withdraw money to cover college costs. In addition, a child can qualify for an individual Roth account if he or she has earned income up to the annual $5,500 contribution limit. Under current rules, principal in a Roth can be withdrawn at any time without paying tax or penalties. Earnings from a Roth must be held for at least five years to avoid both tax and penalties. However, you can withdraw earnings for higher education and avoid an early withdrawal penalty if the amount is less than the annual total for qualified college costs such as tuition and room and board. You still would be required to pay tax on the amount withdrawn.
The earlier families begin planning for college costs, the better prepared they and their children will be when it’s time to choose a school. Although it can be difficult, if not impossible, to know what young children or teens ultimately will choose for a college and career path, having a plan in place and understanding the financial advantages of using gifts to cover college costs can help guide your decisions.
Heath Moore is a wealth advisor with Bronfman E.L. Rothschild, www.belr.com.
Bronfman E.L. Rothschild, LP is a registered investment advisor. Securities, when offered, are offered through Baker Tilly Capital, LLC, member of FINRA and SIPC; Office of Supervisory Jurisdiction located at 10 Terrace Court, Madison, WI 53718, phone 800.362.7301. Bronfman E.L. Rothschild, LP and Baker Tilly Capital, LLC are not affiliated.
Bronfman E.L. Rothschild, LP does not give tax advice. This publication should not be viewed as a recommendation, an offer to sell, or a solicitation of an offer to buy a particular security or service. The commentary provided is for informational purposes only and should not be relied on for accounting, legal, tax, or investment advice. Financial information is from third-party sources. While such information is believed to be reliable, it is not verified or guaranteed. Performance of any indexes is provided for reference and competitive purposes only without factoring any fees, commissions, and other charges. Individual results achieved by investors will be different from those of the indexes. Indexes are unmanaged; one cannot invest directly into an index. The views and opinions expressed are those of Bronfman E.L. Rothschild, LP, and they are subject to change at any time. Past performance does not imply or guarantee future results. Investing in securities involves risks, including possible loss of principal. Diversification cannot assure a profit or guarantee against a loss. Investing involves other forms of risk that are not described here. For that reason, you should contact an investment professional before acting on any information in this publication. © 2015 Bronfman E.L. Rothschild, LP
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