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Having Trouble Coming Up With Your
Grandkid's Graduation Gift? Try the Gift of Tax-Advantaged
Savings
It's a few short weeks until cap and gown season begins, and
for grandparents hoping to do something nice for their grandkids
and something sensible for their estate, there are several
options to explore.
Roth IRAs. The Roth option is a good one if you want
to help them start a retirement fund of their own or if you want
them to inherit a Roth where they can make tax-free withdrawals
after your death.
Roth IRAs aren't a useful alternative for very young kids
because the rules state that all Roth holders have to have
earned income to be able to make contributions. If they fit that
description — as many kids working in high school do — either
their parents or guardians can open the account and grandparents
can make contributions to match the percentage of earnings kids
put in their Roth IRA. Grandparents simply match that
contribution.
Also, if you have a Roth IRA, you can benefit your
grandchildren by naming them as your primary beneficiaries, and
when they inherit it, they'll be able to make tax-free
withdrawals for a home, an education or any other purpose.
Parents or grandparents may want to consider setting up and
funding a Roth IRA for their children or grandchildren as soon
as the children or grandchildren have enough earned income from
part-time or summer jobs. This will ensure that the five-year
requirement is met when the individual for whom the Roth IRA is
established is ready to make a withdrawal to buy a home, for
example.
529 Plans. Another great tool for grandparents is the
529 college savings plan. Grandparents can fill out a plan
enrollment form designating a grandchild as beneficiary, select
the investments from the plan's options, and make future
contributions either by check or by automatic contribution. It's
also fine for grandparents to make their contributions directly
to a 529 account already owned by the grandchild's parents.
As a refresher, 529 college savings plans — named for the
federal law that created them in 1996 — allows a parent to open
a tax-deferred college savings plan with as little as $25 to
start in some states. A 529 college savings plan is not the same
thing as a 529 prepaid college tuition plan. Prepaid tuition
plans are just that — tax-deferred savings plans that allow you
to save for tuition for in-state schools (though some plans
allow you to transfer out a portion of those assets to
out-of-state schools). Also, it's important to note that prepaid
tuition plans are not an automatic guarantee a student will get
into that college.
Since 2006, withdrawals from 529 plans have been permanently
tax-free. In some states, contributions may also be deductible
on state tax returns. All 50 states now have 529 plans college
savings plans, and a majority of them provides additional
incentives, such as a state-tax deduction to in-state residents
who invest in their respective plan.
It's a good idea to have your financial adviser or your
CERTIFIED FINANCIAL PLANNER professional help you sort through
the details of various state plans. There are various services —
including Morningstar Inc. — that now rank the offerings of each
state's plan. (www.SavingforCollege.com
and www.FinAid.org
are leading sites to help educate you in how these plans work.)
Grandparents can treat their contribution as complete gifts,
which means they can apply the $12,000 per year gift tax annual
exclusion or an accelerated contribution of up to $60,000, with
a special five-year, gift-spreading election. Check with your
tax adviser first.
Another great benefit is that a 529 plan owned by
grandparents should not affect the grandchild's eligibility to
receive federal financial aid because a grandparent's assets are
not reportable on the free application for federal student aid,
or FAFSA, and the tax-free withdrawals from a grandparent-owned
529 plan are not counted as student income or student resources.
Coverdell Education Savings Accounts. For
grandchildren heading to private school who are under the age of
18, most grandparents — check your eligibility with a tax
professional first — can contribute up to 2,000 dollars annually
per grandchild to a Coverdale Educational Savings Account.
Coverdell earnings accumulate free of federal income taxes, and
can be taken to pay for private elementary, secondary or
college. Yet, your income is a factor. You can make a Coverdell
contribution as long as your modified adjusted gross income is
between 95,000 and 110,000 dollars if you're single or between
190,000 and 220,000 dollars if you're a married and filing
jointly. Yet, if you exceed either of these requirements, you
can ask the parent of the adult child to open up the account and
make the contribution, though you will have to give up control
over the account.
Make a direct gift of your grandchild's tuition. Under
current tax law, you can make gifts of any amount to cover your
grandchild's tuition. Yet, you're going to need to pay the
college directly and you need to be aware that it won't dent
your federal estate tax exemption (3.5 million dollars in 2009),
but it will cut the overall amount of your taxable estate. You
can, however, go ahead and make additional gifts per grandchild
of $13,000 to help with other college expenses.
March 2009 — This column is produced by the Financial
Planning Association, the membership organization for the
financial planning community, and is provided by Don McCarty of
Financial Decision Partners, a local member of the FPA.
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