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Grandparent’s Gift of an Education

Grandparents often wonder as a part of their estate planning how to best transfer funds to their grandchildren while avoiding negative income tax consequences in the process. The answer might just be a Qualified Tuition Plan, most commonly referred to as a Section 529 plan (529 denotes the section of the tax code that governs it).

State-run Sec. 529 plans usually have a high contribution ceiling, although contributors often choose to stay below the gift tax limit of $15,000 for 2021 (which will increase to $16,000 in 2022). For one-time high-value contributions a special rule allows to spread the amount over five years for a total of gift tax-free limit of $75,000 in 2021 and $80,000 in 2022.

Withdrawing the actual contribution amounts is never taxable and will qualify for the American Opportunity Tax Credit provided the income level of the beneficiary does not phase it out. Any earnings will remain tax-free if used to pay for qualified college expenses, registered and certified apprenticeship programs, trade schools, or elementary through high school education (with the last having a $10,000 a year limit per beneficiary).

A 10% penalty is assessed on the earnings portion of non-qualified withdrawals, but a 529 plan comes with a generous rollover provision which allows for the funds to be moved from one family member to another if their educational goals change. Alternately, an account can be established in the parents’ names to be later divided between children as needed as there is no age limit on the plan’s beneficiary.

The maximum amount that can be contributed per beneficiary (the intended student) is based on the projected cost of college education and will vary among the states’ plans. Some states base their maximum on an in-state four-year education, but others use the cost of the most expensive schools in the U.S., including graduate studies. Most have limits over $200,000, with some topping $530,000. Generally, no additional contributions can be made once the total to the beneficiary reaches that level, but this does not prevent the account from continuing to grow.

Taxpayers are also not limited to participating in the 529 plan offered by their state of residence and can shop around for the plan with the best growth potential and highest maximum contribution.

While there is currently no tax benefit for contributing to a 529 plan on the federal level, many states offer tax breaks for contributions made to the states’ programs. For Virginia the deduction cap is $4,000 per beneficiary per tax payer if the tax payer is under seventy years old. Over seventy years old the cap is lifted and the deduction limited only by outside factors discussed previously.

In addition to the annual gift tax exclusion, a donor may make gifts (with no specific dollar limitation), which are excluded from the gift tax when making payments directly to an educational institution for tuition. This includes both college and private primary education. However, these gifts can only pay for tuition, which does not include books, supplies, or room and board. It is critical that the payments be made directly to the educational institution for them to be excluded from the gift tax. Reimbursement paid to the donee will not qualify.

For more details or assistance in planning for a child’s higher education, please contact our Leesburg or Warrenton office.

Leesburg Office    5 Loudoun St. SW Ste. B Leesburg, VA 20175           Phone 703.771.1818  Fax 703.777.5708 

Warrenton Office  10 Rock Pointe Lane Ste. 3 Warrenton, VA 20186        Phone 540.347.5681  Fax 540.347.3353