Education Planning

Education costs in the United States has continually increased.   Therefore, it is critical to plan for the educational expenses of a child, grandchild or other loved one at an early age. Procrastination will not solve the problem; rather it will just delay the inevitable. 

There are various tax-efficient methods to plan and/or pay for the educational expenses of a loved one, including 

  • Section 2503(e) Gifting.   Section 2503(e) of the Internal Revenue Code excludes from taxable gifts any amount paid as tuition to an educational institution on behalf of an individual. This provision is not really an educational savings vehicle, but rather a way to pay for the education of a loved one without incurring any adverse gift tax consequences. Under Section 2503(e), a person can make unlimited tax-free gifts of tuition on behalf of as many persons as he or she chooses without incurring a gift tax and without utilizing any portion of that person’s annual gift tax exclusion or applicable credit.  In order to get the benefit of making unlimited gifts of tax-free tuition, certain requirements most be met, including the tuition payments must be made directly to the educational institution.
  • Education Savings Accounts.  Education Savings Accounts were formerly referred to as Education IRAs, but the Economic Growth and Tax Relief Reconciliation Act of 2001 not only changed the name of this educational savings plan but also made it more attractive from a tax perspective.  A taxpayer can make a nondeductible contribution to an Education Savings Account in order to establish a fund to pay for the future educational expenses of a loved one. The amount that can be contributed to this Education Savings Account is $2,000 per year.  Amounts contributed to an Educational Savings Account will count toward a portion of the contributor’s annual gift tax exclusion.  Each beneficiary of an Education Savings Account is limited to $2,000 in total contributions per year regardless of the number of donors. Thus if the parents and both sets of grandparents set up an Education Savings Account on behalf of one child, a maximum of $2,000 can be contributed in total by all family members on behalf of this one child.  Although contributions made to an Education Savings Account are not deductible, the income and earnings in the account are not subject to current income tax. Further, distributions from the account that are used for the beneficiary’s qualified educational expenses are excluded from income.  Special rules govern Education Savings Accounts, including income and phase-out limits for higher income taxpayers. 
  • 529 Plans.  Section 529 Plans are Qualified State Tuition Programs that may be established and administered by states.  In Missouri, the program is referred to as the “Missouri Savings for Tuition Program” or the “MO$T” Plan. To learn more about Missouri'sspecific program you should visit their website located at www.missourimost.org.  Many financial institutions and brokerage companies offer Section 529 Plans to their clients. This is typically done by the financial institution or brokerage company utilizing a Qualified State Tuition Program of a particular state. The different states that offer Section 529 Plans differ from each other in many respects, including the investment options available for funds put in a Section 529 Plan. To learn more about any states’ Qualified Tuition Program, you can visit the website www.savingsforcollege.com.  Contributions to a Section 529 Plan are not tax deductible for federal income tax purposes. However, certain plans from certain states provide favorable state income tax treatment for contributions. For example, Missouri'sMO$T Plan provides a state income tax deduction for contributions of up to $8,000 per year per taxpayer. With this deduction, the maximum tax savings for Missouri residents who participate in the plan is $480 for an individual and $960 for a married couple.  The income and earnings associated with a Section 529 Plan are not subject to current taxation. In addition, distributions made from a Section 529 Plan for qualified education expenses will be tax-free. There are no income limits on the person establishing a Section 529 Plan. This means that individuals whose income would prevent them from contributing to an Education Savings Account can still make a contribution to a Section 529 Plan.  Another unique feature of a Section 529 Plan is that a contribution is deemed a completed gift to the beneficiary and is not a future interest in property, even though the donor retains substantial control over the account. The donor retains the right to control withdrawals and to change beneficiary designations.  Thus, the donor keeps control over the money while at the same time giving it away for estate and income tax purposes.
  • Section 2503(c) Trusts.  Section 2503(c) of the Internal Revenue Code provides a special provision, which allows an individual to establish an irrevocable trust to fund a beneficiary’s education without having adverse gift tax consequences, if the beneficiary is under the age of 21 years.  Generally a gift to a donee is only eligible for annual exclusion limits if the donee has a present interest in the gift. The taxpayer can create a 2503(c) Trust and gifts to the trust automatically qualify for the gift exclusion if they are below the annual limits. A 2503(c) Trust can receive separate gifts from parents, grandparents, or others.  A Section 2503(c) Trust does not offer the same benefits as the Educational Savings Account or Section 529 Plan in that it does not provide for tax-free build up of income or earnings nor does it provide for tax-free distributions. However, the funds in the trust can be used not only for education, but also for other purposes such as a beneficiary’s health, maintenance or support. In addition, since it is the taxpayer who establishes the trust, the taxpayer can select the trustee of the trust (i.e., the person who administers the trust) so that the trustee has more control and unlimited flexibility over the investments and distributions.
  • Irrevocable Trusts.  Instead of establishing a Section 2503(c) Trust, a taxpayer can establish an irrevocable trust to fund a loved one’s education. The main difference between a Section 2503(c) Trust and an irrevocable trust is that the initial contribution to the trust may be subject to adverse gift tax consequences unless the beneficiary of the trust is given the immediate right to withdraw the funds gifted to the trust.
  • Tax Credits.  Two tax credits are available for higher education – the American Opportunity credit and the Lifetime Learning credit. They are both nonrefundable personal credits and both are subject to phase-outs based upon an individual’s adjusted gross income. The credits phase out at adjusted gross income ranges of $80,000 to $100,000 for joint returns and $40,000 to $50,000 for other returns.  The American Opportunity credit allows a credit of up to $2,500 per student for tuition and fees for each of the first two years of college. The Lifetime Learning credit is worth up to $2,000 per year for an unlimited number of years for college juniors, seniors, graduate students, or working Americans pursuing job skill training.

To learn more about the tax consequenses of planning and paying for the education of a loved one, please contact us for a free initial consultation or ask for our brochure titled "Planning Techniques for Funding an Education."

 

The Law Office of Richard C. Petrofsky assists clients with Estate and Gift Planning, Wills, Trusts, Charitable Planning, Special Needs Planning, Elder Law and Medicaid Planning, Estate and Family Planning for Same-Sex Couples and LGBT Individuals, Asset Protection Planning and Corporate and Business Planning in St. Louis, Missouri and surrounding areas.