Tax-Smart Ways to Help Your Kids or Grandkids Pay for College

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Tax-Smart Ways to Help Your Kids or Grandkids Pay for College
Estimated Annual Future College Costs
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Nota bene: Do you want to know how much it will cost to send your kid or grandchild to college? Use the College Savings Plans Network’s College Cost Calculator.

Keep in mind that these prices are for a single year; the amount of years your kid attends college will depend on the degree(s) they choose to pursue. While many students may be eligible for financial assistance, scholarships, and grants to assist with college expenses, there are a number of methods to reduce college prices.

One of the simplest methods to invest money put aside for your kid or grandchild’s college years is in tax-advantaged investment vehicles. These plans and accounts enable you to save for your child’s or grandchild’s education while concealing the funds from the IRS to the greatest extent feasible.

529 Plans

“Using a 529 college plan is one of the finest ways to aid a kid financially while lowering your personal tax obligation,” says Sam Davis, partner/financial adviser at TBH Global Asset Management. A 529 plan is a tax-advantaged investment plan that allows families to save for a beneficiary’s future education expenses.

Contributions to the plans are restricted to after-tax monies. Each year, you may donate up to the annual exclusion amount, which is $15,000 in 2021. (the “annual exclusion” is the maximumamount you can transfer by gift, in the form ofcash or other assets, to as many people as you wish,without incurring a gift tax).In 2022, the sum will be increased to $16,000. All withdrawals from a 529 plan are tax-free as long as they are spent for eligible educational costs (most states offer tax-free withdrawals, as well).

Those with the means may “superfund” a 529 plan by making five years’ worth of donations at once, per kid, per person, without incurring the gift tax. This implies that a couple of super-rich grandparents, for example, may pay $75,000 each ($150,000 per couple) while a kid is small and let the money grow to cover their whole expenditures. There are intricate restrictions for doing this, so don’t do it unless you have extensive tax guidance.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act, which President Donald Trump signed into law in December 2019, included a number of features aimed at improving retirement and savings programs. Under the new legislation, 529 plan money may now be used to repay up to $10,000 in student debts, as well as to pay for expenditures associated with registered apprenticeship programs.

Types of 529 Plans

There are two types of 529 plans:

College Savings Plans

These savings programs, including 401(k)s and individual retirement accounts (IRAs), invest your contributions in mutual funds or other investment products. Account profits are determined by the underlying assets’ market performance, and most plans include age-based investment alternatives that grow more conservative as the beneficiary approaches college age. Only at the state level can 529 savings schemes be handled.

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Prepaid Tuition Plans

Prepaid tuition programs (also known as guaranteed savings plans) enable families to lock in today’s tuition rate by buying tuition ahead of time. When the recipient is in college, the program pays out at the future cost to any of the state’s qualified schools. If the beneficiary ends up attending an out-of-state or private school, you may transfer the account amount or get a refund. Prepaid tuition plans may be handled by governments and higher education institutions, albeit they are only available in a few states.

“I highly urge my customers to fund 529 plans since the income tax savings are unparalleled,” Davis adds. “While contributions are not deductible on your federal tax return, your investment grows tax-deferred, and disbursements to cover the beneficiary’s education expenses are federally tax-free.”

Traditional and Roth IRAs

An IRA is a tax-advantaged savings account in which you may invest in stocks, bonds, and mutual funds. You get to choose the investments in the account and may alter them as your needs and objectives change.

The SECURE Act allows you to defer taking required minimum distributions (RMDs) until the age of 72, and the legislation eliminates the age limit for putting money into a traditional IRA, so you may continue making contributions at any age if you are still working. In general, if you take from your IRA before the age of 5912, you will have to pay an extra 10% tax on the early distribution.

However, you may take funds from your conventional or Roth IRA before reaching the age of 5912 to pay for eligible higher education costs for yourself, your spouse, or your children or grandchildren in the year the withdrawal is made without incurring the 10% extra tax. The waiver only applies to the 10% penalty; unless the distribution is a Roth IRA, you will still incur income tax on it.


There are a handful of disadvantages to using your retirement assets to pay for your child’s or grandchild’s college tuition:

  1. It depletes your retirement fund, which cannot be replenished (unless you are still working), therefore you must ensure that you are well financed for retirement outside of the IRA.
  2. IRA payouts might be recognized as income on the next year’s financial aid application, affecting need-based financial aid eligibility.

To avoid having to draw into your own retirement, you may be able to set up a Roth IRA in the name of your kid or grandchild. The caveat is that your kid (not you) must have earned revenue from a job during the year for which you are making a contribution. You may support their yearly payment up to the maximum amount, but only if they work.

The IRS is unconcerned with where the money comes from as long as it does not exceed the amount earned by your kid. If your kid earns $500 from a summer job, for example, you may make the $500 contribution to the Roth IRA with your own money, and your child can use the money for anything else.

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Here’s how to go about it: If your kid is a juvenile (under the age of 18 or 21, depending on where you reside), many banks, brokers, and mutual funds will allow you to set up a custodial or guardian IRA for them. You (the adult) manage the funds in the custodial IRA as the custodian until your kid reaches the age of majority, at which time the assets are given over to them.


A Coverdell Education Savings Account (ESA) may be opened at a bank or brokerage business to assist pay for your child’s or grandchild’s approved education expenditures. Coverdell ESAs, like 529 plans, enable money to grow tax-free, and withdrawals are tax-free at the federal (and, in most instances, state) levels when used for eligible school expenditures.

Coverdell ESA benefits are available for both higher education and primary and secondary education costs. If the funds are utilized for nonqualified costs, you will be required to pay tax as well as a 10% penalty on profits.

Contributions to a Coverdell ESA are not deductible, and they must be paid before the recipient reaches the age of 18. (unless the child is a special needs beneficiary, as defined by the IRS).While a single beneficiary may have several Coverdell ESAs, the maximum contribution per beneficiary (not per account) each year is $2,000.

To contribute to a Coverdell ESA, your MAGI must be less than $110,000 for a single filer or $220,000 for a married couple filing jointly.

Custodial Accounts

Custodial accounts such as Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) enable you to place money and/or assets in a trust for a young child or grandchild. You handle the account as trustee until the kid reaches the age of majority (18 to 21 years of age, depending on your state).When the kid reaches that age, they control the account and may spend the money anyway they see fit. This implies they are not required to utilize the funds for educational purposes.

Although there are no contribution restrictions, parents and grandparents may limit individual yearly donations to $15,000 ($30,000 for married couples) to avoid incurring the gift tax. In 2022, these sums will rise to $16,000 and $32,000, respectively. One thing to keep in mind is that custodial accounts count as student assets (rather than parent assets), thus substantial balances might restrict financial aid eligibility. The government financial-aid model requires students to pay 20% of their savings, while parents may contribute up to 5.6% of their assets.


The yearly exclusion lets you to gift $15,000 in cash or other assets to as many individuals as you choose in 2021 (rising to $16,000 in 2022). Spouses may combine yearly exclusions to contribute $30,000 (up to $32,000 in 2022) tax-free to as many people as they choose.

You may give a kid up to the annual exclusion amount each year as a parent or grandparent to assist pay for college or other higher education fees. Gifts that exceed the annual exclusion count towards the lifetime exemption, which is $11.7 million per person in 2021 (rising to $12.06 million in 2022).

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Are you worried about the lifetime exemption? You may assist your grandchild pay for college while lowering your personal tax obligation as a grandparent by making a donation straight to their higher-education institution.

“Grandparents may pay the educational expenditure directly to the provider, and that does not count against the yearly exclusion of $15,000,” says Joanna Foster, MBA, CPA. As a result, even if you donate $20,000 to your grandchild’s education each year, the amount above $15,000 ($5,000 in this example) does not go towards the lifetime exemption.

Why Is It Never Too Early to Start Saving for College?

Rising college expenditures have no end in sight. College prices, on average, rise at almost double the rate of inflation each year. It is suggested that you begin saving for your child’s or grandchild’s college expenses as soon as possible.

How Much Might College Cost for a Family Whose Child Is a Toddler in 2021?

According to the Education Savings Plans Network, the cost of college for a toddler in 2021 is anticipated to be $261,277 for four years of in-state, public college, including tuition, fees, lodging, and board. It is anticipated that a private college will cost $598,063.

What Are Examples of Education Savings Accounts That Will Help People Plan for College Expenses?

A 529 plan is one of the most tax-efficient methods to save for college. They are available as either savings programs or prepaid tuition plans. Another common method to save is via Coverdell ESAs. A plan may be set up at a bank or brokerage business to assist pay for your child’s or grandchild’s approved school expenditures. Coverdell ESAs, like 529 plans, enable money to grow tax-free, and withdrawals are tax-free at the federal (and, in most instances, state) levels when used for eligible school expenditures.

The Bottom Line

Many individuals approach college savings in the same way they do retirement savings: they do nothing because the financial commitments seem daunting. Many individuals claim that their retirement strategy is to never retire (not a real plan, needless to say, unless you die young).Similarly, parents may joke (or believe) that the only way their children will be able to attend college is if they get a full scholarship.

Apart from the apparent problem, this strategy is a backseat approach to a scenario that requires a front-seat driver. Even if you can just save a little sum of money in a 529 or Coverdell plan, it will assist.

For most families, paying for college is more complicated than just sending a check each quarter. Instead, it is a combination of financial help, scholarships, grants, and money earned by the kid, as well as money given to tax-advantaged college savings vehicles by parents and grandparents.

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