Coordinate college savings with your estate planning | Warner Norcross + Judd

During our discussions about estate planning, parents and grandparents often tell us about their hopes and dreams for the next generations of their families. Helping children and grandchildren reach their full potential often means helping them pay for additional education after high school.

With the rising costs of higher education, most people will need to save for these expenses. Starting your savings plan early is essential. Another key is to coordinate your college savings plan with your estate and tax planning, as there are many tax benefits to saving for the education needs of the next generation.

Keep in mind that for most of your savings options, savings vehicle assets will be considered an asset of the student on their Free Application for Federal Student Aid (FASFA) form and could affect their eligibility for financial assistance or the amount. financial assistance they are eligible for.

529 plans are a tax-efficient savings choice

529 plans coordinate well with estate and tax planning because

  • You can fund them with annual exclusion gifts, which are not subject to federal gift tax. For 2022, the annual exclusion (the tax-free amount you can gift each person per year) is $16,000 per donor or $32,000 per married couple donating.
  • You can preload a 529 plan in one year with up to five years of annual exclusion gifts, which means up to $80,000 from a single person or $160,000 if you’re married.
  • The growth of plan assets is not subject to income tax.
  • Some states, including Michigan, allow you to deduct the amount contributed to the plan from your state taxable income each year (up to the state deduction limit).

Family members have two options for a 529 plan:

  1. 529 prepaid tuition plan. These plans, like the Michigan Education Trust (MET), allow you to purchase future tuition credits at the current price. The plan covers tuition and fees (but generally not room and board) when the student later attends a public college or university in the state.
  2. If the child does not attend college or receive a scholarship, the credits can be transferred to another family member or your contributions can be refunded to you, although subject to a penalty.
  3. Students can attend an out-of-state or private school, but will have to pay the difference between the most expensive tuition and the average in-state public school tuition.
  4. 529 savings account. These plans, like the Michigan Education Savings Program (MESP), allow you to put funds into one or more investment accounts and then use the funds for the beneficiary’s higher education expenses. Your account growth is based on the performance of the investment options you select, so these plans carry investment risk.
  5. Distributions from this account will not be taxed as long as they are used only for “qualifying higher education expenses” such as tuition, room and board, books, and computers.
  6. Money that is disbursed from the account but not used for eligible educational expenses is subject to federal taxes and a penalty of at least 10%. However, unused funds may be transferred and used by an eligible family member of the beneficiary.

Less Conventional Options for Saving for Education Expenses

Depending on your tax or estate planning goals, other savings options may coordinate well. Like the 529 plans, these options can be financed by annual exclusion gifts:

  • Donation trusts. Generally, irrevocable gift trusts are a great customizable tool used to save for education expenses, allowing the settlor to select the purposes for which the funds can be used and at what age the beneficiary can withdraw the assets. Income generated by the assets of the trust is subject to the income tax rates of the trust and the settlor does not have to act as a trustee.
  • Section 2503(c) Trust of a Minor. This is a specific example of a more complex gift trust that has only one beneficiary and can be structured to allow the beneficiary to choose whether or not to exercise their right to the assets at the age of 21 years old. Donations to these trusts are considered annual exclusion donations. as long as the beneficiary is under the age of 21. Distributions from this trust may be narrowly tailored for educational purposes or permitted for broader purposes, but the assets of the trust may only be used for the benefit of the designated beneficiary. Income generated by the assets of the trust is subject to the income tax rates of the trust and the settlor does not have to act as trustee.
  • UTMA (Uniform Transfers to Minors Act) or UGMA (Uniform Gift to Minors Act) deposit account. These accounts are created in accordance with state law to hold gifts made to a minor and are maintained for the minor by a custodian. The Custodian of the Account may be, but need not be, the child’s parents or a person donating assets to the Account. Ownership of this account must be transferred to the child at a specific age (usually 21, but this age varies by state). The assets in this account do not have to be used for education, but they can only be used for the benefit of the designated beneficiary. Income earned on account assets is taxed to the beneficiary but, in some cases, could be taxed at the parent rate.

Get started with an education savings plan

It’s never too early to start saving or to realize that your estate planning lawyer can help you choose a plan that will meet your savings goals over time and avoid unintended tax consequences.

About Kristina McManus

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