Littlejohn column: Four tax-friendly ways to help out with education expenses

Brian Littlejohn

According to the Bureau of Labor Statistics, the cost of college tuition has increased a staggering 181.2% since the year 2000. In comparison, the cost of goods and services in our economy overall rose 76.1% during that same period.

As the cost of college tuition continues to skyrocket, many people are looking for ways to reduce these expenses. And, if you’ve amassed more money than you’ll ever spend, you may be trying to find tax-efficient ways to transfer some of it to future generations. Funding education expenses for your younger family members can be a great way to achieve both objectives.

Taxes on gifts

Unfortunately, gifting large sums of money to family members usually comes at a cost. In 2023, if you give someone more than $17,000 ($34,000 if you’re married), there will likely be federal gift tax consequences. The IRS also imposes something called a generation-skipping transfer tax (GST tax), which discourages people from deliberately skipping the next generation in their estate plan in favor of younger generations.

These taxes are complex and can be a headwind when it comes to assisting younger family members financially. Fortunately, there are strategies you can use to transfer some large sums of money without incurring a hefty tax bill — especially if your younger family members want to further their education.

Consider these four strategies:

1. Fund Education Expenses Directly

One of the simplest ways to fund your family’s education expenses is to pay the educational institution directly. This will help you avoid both federal gift and GST taxes. In addition, the amount paid won’t count towards your $17,000 annual exclusion or lifetime exemption.

Notably, this strategy isn’t limited to college-related expenses. You can pay for any level of education for your family members tax-free, as long as you write the check directly to the institution.

2. “Superfund” a 529 Plan A 529 plan is an investment account that offers certain tax advantages if the funds are used to pay qualifying education expenses. Currently, you can contribute up to the annual exclusion amount to a 529 account each year without incurring any gift tax.

In addition, many people don’t realize that you can contribute up to five years of gifts at once, per beneficiary. Meaning that, in 2023, you can contribute up to $85,000 ($170,000 per couple) to a 529 account at one time. That money can then grow tax-free until the beneficiary is ready to use it.

It’s important to note that the tax treatment of 529 plans varies by state. To avoid unintended tax consequences, be sure to speak with your financial advisor or tax professional before implementing this strategy.

3. Make Annual Tax-Free Gifts

If you can’t “superfund” a 529 plan, you can always make tax-free annual gifts of up to $17,000 ($34,000 if you’re married) to as many people as you’d like. You can use this strategy to fund a Uniform Transfer to Minors Act (UTMA) account, an IRC Section 2503(c) Trust, or even a Crummey Trust.

These accounts can confer similar benefits as a 529 plan and they usually allow you to maintain more control over your gifted assets. However, these strategies can also be more complicated and costly to implement. It’s typically a good idea to consult an estate planning attorney to determine what type of account makes the most sense in your situation.

4. Lend Your Family Members Money

You may decide that you want to support younger family members financially without giving them money outright. Instead, you can lend them money to pay for their education expenses. Each month, the IRS releases Applicable Federal Rates, which represent minimum interest rates for family loans to avoid tax complications. These interest rates vary depending on the term of the loan. However, they’re typically more favorable than federal or private student loan rates.

If you opt to go this route, be sure to work with an attorney to draw up a contract. This can help both parties avoid any misunderstandings regarding the assistance.

Funding education expenses for future generations

If you’ve been fortunate enough to accumulate a sizeable nest egg during your lifetime, you may be thinking about impactful ways to pay it forward to future generations. Since the IRS limits tax-free transfers, careful tax and financial planning undertaken now can help you do this more efficiently should you decide to provide this type of assistance.

Brian Littlejohn, MBA, CFP®, CFA is the founder of Sherwood Wealth Management, an independent registered investment advisor firm. He specializes in inherited wealth and works with clients in the Roaring Fork Valley and beyond.

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