There are unique advantages to grandparents paying for their grandchildren’s early schooling. Most nanas and pop-pops have undoubtedly heard of the advantages of contributing to a 529 plan. This sort of account assists in paying off those hefty schooling expenditures by enabling their issue to withdraw funds tax-free to pay for tuition, books, supplies, and fees at a range of colleges, universities, and vocational and trade institutions.
However, the costs of private preschools and primary institutions may be frightening. It’s particularly true in some of the country’s biggest cities, where tuition may outpace that of in-state universities. Some of the most prestigious elementary schools in New York City, for example, might cost more than $30,000 per year. With a 529 plan, parents may utilize up to $10,000 for tuition only at private, public, or religious elementary and secondary schools.
The Tax Cuts and Jobs Act of 2017 and the SECURE Act, also known as the Setting Every Community Up for Retirement Enhancement Act and signed into law on December 20, 2019, both enlarged 529 plan eligible costs. 529 plan assets, however, cannot be used for preschool or childcare services.
- There are tax advantages for grandparents to assist their grandchildren with educational costs, including preschool.
- These approaches assist your children with expenditures and benefit your family as a whole by minimizing the amount of your estate, hence reducing the possibility of ever being charged an estate tax.
- You may take advantage of the gift tax exemption, which allows you to make donations of up to $16,000 (per 2022 regulations) without the amount being applied to your lifetime estate and gift tax limitations.
- You may also avoid the gift tax entirely by paying the education costs directly to the program; no taxes are required when payments are made for qualifying school expenditures.
- You may also open a Coverdell Education Savings Account (ESA) for your grandchild, albeit the gift limits are minimal and your income cannot exceed certain thresholds.
The Benefits of Paying
Fortunately, the Internal Revenue Service (IRS) provides several attractive tax breaks for grandparents who wish to assist with early childhood education. Taking use of these laws may help you stretch every dollar you spend, as well as protect your assets from the taxman when your estate is handed down to your heirs.
A unique IRS provision permits donors to stretch one-time payments across five years of gift-tax exemptions without the money counting against the lifetime estate and gift tax maximum; for example, a grandmother may pay $75,000 in one year and consider it as having been paid over five years.
The Gift-Tax Exemption
Ordinarily, a taxpayer may only give each grandchild (or anybody else) $16,000 per year in 2022 ($15,000 in 2021) without incurring the gift tax. The amount is per person, thus a couple may gift each grandchild $32,000 per year in 2022 ($30,000 in 2021).
To be sure, the gift tax does not have to be paid right away, and in certain situations, it does not have to be paid at all. Gifts that exceed the $16,000 limit for 2022 ($15,000 for 2021) contribute toward the lifetime exemption from gift and estate taxes. The exemption in 2021 is $12.06 million ($11.7 million in 2021).
However, if you pay your grandchild’s school directly to cover tuition expenses, that restriction does not apply. This “education exemption” is an excellent method for people to contribute to the high expenses of private education.
It’s also a fantastic estate-planning tool for elderly folks with substantial assets. Any money you give your grandchildren today reduces the amount of your estate for tax reasons. This may be significant for the richest Americans, considering that the government collects up to 40% of any estate valued at more than $12.06 million in 2022 ($11.7 million in 2021). Even if your heirs do not pay taxes directly, remaining under that level is a tremendous help to them.
If you want to pay the charges tax-free, the preschool your grandkids attend must be more than simply a daycare center, according to IRS standards.
The Preschool Factor
In principle, grandparents may utilize the education exemption to pay for preschool expenses as well. But here’s where things become complicated. You’re out of luck if the preschool is more of a daycare center than an educational institution. “A qualified educational organization is one that typically maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the venue where its educational operations are regularly carried out,” according to IRS Form 709.
So, if you want to pay tuition in a high-cost area of the nation, be sure to choose a school that meets the requirements. It’s also worth noting that the exemption only applies to qualifying tuition expenditures. It will not cover auxiliary fees like books and materials.
If the youngster enrolls in a school that needs a contract, experts advise that the person paying the bill, even if it’s a grandmother, should sign it. Otherwise, the IRS may claim that the grandmother made a taxable gift to the parent, even if this is not the case.
Many astute grandparents are aware of 529 college savings plans, but there is another, more flexible alternative that sometimes goes unnoticed. With a Coverdell Education Savings Account (ESA), you may help your grandchildren save not just for college but also for elementary and secondary school tuition and other relevant expenses.
If you give money to a 529 plan, recipients may withdraw it tax-free for specified educational costs, which now include repaying student debts up to $10,000, pursuant to the SECURE Act. Furthermore, the bill broadened 529 plans to cover apprenticeship program fees. ESAs, on the other hand, tend to provide more investment possibilities and cheaper fees.
The relatively modest income restrictions for Coverdell plans are one stumbling issue. You may contribute up to $2,000 per year to a grandchild’s account in 2021 if your modified adjusted gross income is less than $95,000 per year—or $190,000 if you file a combined return. At that time, the allocation begins to decrease. Those with a modified adjusted gross income of more than $110,000 (or $220,000 if filing jointly) are fully barred from donating.
However, there is a rather simple fix. Simply provide the money to your grandkids and instruct them to start their own ESA. Allowing them to save for a private school in a tax-advantaged manner allows you to get more bang for your buck. Furthermore, there is another technique to reduce the amount of your inheritance, which may assist wealthy families avoid the dreaded estate tax.
The Bottom Line
The IRS provides a handful of possibilities for grandparents who wish to contribute to the cost of private preschool and elementary education. Taking advantage of these exemptions may help you reduce your tax payment now and in the future. If you pay tuition directly, be sure the institution is eligible for the gift-tax exemption.
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