College Tuition Planning - Palos Verdes Magazine

College Tuition Planning:
Questions to Ask Your Accountant and Financial Advisor

Contributed by Gregory Becker

Planning for college tuition is on the minds of many parents. The graduation season is filling our rear-view mirror while the next term of classes obstructs the view of oncoming traffic. For those parents with young children, the answer to what college has in store for their family is uncertain. It could be Ivy League coupled with a Masters or it could be a two-year junior college with the student living at home before dropping out to pursue a career in wine making. In either event, President Eisenhower’s quote stays true:

“In preparing for battle I have always found that plans are useless, but planning is indispensable.”

Every advisor would agree that the earlier the planning begins, the more indispensable the planning is. For some, the issue is: how to start planning? As my family is preparing for my eldest son’s enrollment in Cal Poly Pomona, I thought it would be helpful to set forth three tax smart strategies to pay for college. My goal is to help motivate parents and grandparents to begin a dialogue with their advisors who will help determine what is prudent based on their situation.

The three strategies to follow:

529 College Savings Plan: In general, distributions for qualified education expenses are federal income tax-free, but there is no deduction for funding the plan. Qualified education expenses can loosely be defined as tuition, books, equipment and supplies, room and board and computer expenses. 529 plans are flexible. The funds can move to other children, stepchildren and even nieces and nephews who are in the same generation as the beneficiary or a higher one. Each state has its own plan. The rules differ from state to state with some allowing non resident investment.

Recently, the plan has expanded to K-12 and apprenticeships with certain limitations. A common way of funding a plan is through annual tax-free gifting. Under the annual gift exclusion, one can give to another $16,000 tax-free every year. (IRC 2503(b)) For those who want to fund a larger amount, there are two main strategies: First, the plan allows one to contribute five-years (5) of the annual exclusion up front without penalty. (IRC 529(c)(2)(B)). That is $80,000 up front for each donor/spouse.

This may also be a smart way to maximize federal estate tax savings without using the lifetime exclusion from federal estate taxation.

The second strategy requires the use of the lifetime gift tax exclusion to fund large gifts. The amount of the gift exceeding the annual gifting amount will lead to a corresponding reduction in the amount one can exclude from federal estate taxation. This strategy helps remove the gift’s future appreciation from the donor’s estate. Imagine a scenario where a grandparent makes a large gift at a grandchild’s birth. The gift appreciates $350,000 by the time the grandparent dies. Using 40% as the applicable federal estate tax rate, this strategy would save $140,000 from estate taxation.

Contribute to a Roth-IRA: This is a choice for those who prioritize retirement growth. One can take early distributions without penalty if they are for education purposes and adhere to the five year rule. Withdraws are tax-free after 59 ½. Contributions to Roth-IRAs are not deductible. Money in a Roth-IRA may not count against college financial aid; however, money in a 529 plan
may reduce the financial aid for which one can qualify.

Hire Your Child: Hiring one’s child may have beneficial tax impacts depending on their age and whether your business reports on Schedule C or is a corporation. Hiring a child under eighteen years of age through a Schedule C may exempt the child and business from payroll taxes. If operating as a corporation or if a child is over eighteen years, the strategy is to provide the child a one-time-job instead of employing the child. Example: 40% bracket and the corporation will pay the child $24,000. The $24,000 is deducted from taxes which saves over $9,000. Child pays only $1,000 or so and is not subject to self-employment taxes. (Rev. Proc. 2021-45) As a bonus, the child may be able to contribute to an IRA and obtain a tax deduction against the child’s earnings.

Again, in setting forth these three strategies it is my hope that I help others to begin the dialogue with their advisors. Before employing any of these strategies consultations with one’s CPA and Financial Advisor must occur as every family’s situation is different and the federal & state rules and regulations are ever-changing.