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Strategies for Financing a Grandchild's Education

When considering potential gifts for grandchildren, you may want to remember the gift of financing an education. Given that a college education represents a significant expense for many families, your gift may be especially welcome when it comes time to pay tuition bills.

Direct Payment to a College

When grandparents pay tuition bills directly to an institution of higher learning, the payment in any amount is an exclusion to the gift tax laws. In addition, there is not likely to be any impact on the amount of financial aid that the student could potentially receive. Grandparents' assets are not usually part of a grandchild's financial aid calculation unless the grandparents are serving as the custodial parents.

529 College Savings Plans

For grandparents who are interested in reducing the amount of their taxable estate, another strategy for financing a college education is to establish a 529 college savings plan and name a grandchild as beneficiary. While contributing to a 529 college savings plan doesn't have the same advantage of unlimited gift and estate tax exclusion that a direct payment to a college has, there are significant advantages.

For example, a contribution to a 529 college savings plan is considered a completed gift to the beneficiary for estate tax purposes. As a result, those funds are outside of the grandparent's taxable estate yet remain available to the grandchild in the event of the grandparent's death. To avoid triggering a need to file a gift tax return, grandparents can contribute an amount up to the annual gift tax threshold ($13,000 per recipient for the 2009 tax year). If a couple makes the gift
jointly, the annual exclusion is $26,000 per year. If a couple makes the gift jointly, $13,000 the annual exclusion is $26,000 per year.

Also, each grandparent can contribute up to $65,000 ($13,000 x 5) in a single year for each beneficiary, and elect that the gift occurred over a five-year period for gift tax purposes. If, however, the grandparent dies prior to the beginning of the fifth calendar year following the gift, the portion of the gift allocated to the years following the grandparent's death goes back into the grandparent's estate and is taxed accordingly.

Withdrawals used for qualified higher education expenses are tax free. If the beneficiary does not attend college or receives a scholarship, grandparents can designate another family member.

If you are thinking of establishing a 529 plan, be aware that individual states have different programs as well as different tax codes. For example, some state plans allow for additional tax benefits if state residents participate in their state-sponsored plan.

Your financial advisor can help you learn more about strategies that will help you pay for a grandchild's education and potentially benefit your personal financial situation as well. 

This article is not intended to provide specific investment or tax advice for any individual. Consult us, your financial advisor, or your tax advisor if you have any questions.

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