Alternatives for Financing Education Through Gifting: Outright Gifts and Section 2503(E) Gifts
Most planning with young families will eventually include discussions about saving for college. With college costs climbing, parents have to save more aggressively than ever, taking advantage of every possible tax break and ownership structure. This is part one in a series detailing some traditional gifting techniques and latest offerings.
This is the simplest way to transfer assets to a minor child. Because an outright gift will belong to the child immediately and forever, the gift will qualify for the annual gift tax exclusion ($13,000 in 2011, or $26,000 if splitting gifts between husband and wife). While the child is under age 21, the funds can be managed by a parent under the Uniform Transfers to Minors Act (UTMA), which essentially establishes a simple trust for the child. Prior to age 21, the income earned on these assets is taxed at the higher of the child’s or the parent’s top marginal income tax bracket. Any type of property, including real estate, may be transferred to the minor under the provisions of the UTMA.
It is important to note that UTMA does not automatically allow a custodian to manage assets until age 21. Like its predecessor, the Uniform Gifts to Minors Act, UTMA automatically grants authority only through age 18. In order to extend the relationship through age 21, the original transfer to the minor must include the words “as custodian for _______________ (name of minor) until age 21 under the Michigan Uniform Transfers to Minors Act.”
The obvious one is simplicity. UTMA accounts can be established at any bank, brokerage, or mutual fund firm as easily as opening any other account. There are no accounting requirements or separate tax filings to manage. Moreover, earnings on UTMA assets can be taxed at the child’s rate after attaining age 19, or 24 if the child is a dependent full-time student.
The biggest is control – once a beneficiary reaches age 21, the child can control the account and can spend the money as he or she sees fit. Also, assets of an UTMA account would negatively affect financial aid availability as the money is considered part of the child’s savings, a factor which weighs heavily when schools are determining aid. If you’re concerned about estate taxes, it’s important to avoid naming yourself as custodian. If you die before the account terminates, the account will be included in your estate. This is true even though the transfers to the account are completed gifts. This problem can be avoided by naming as custodian someone who will not make any gifts to the account. For example, a grandparent might name the parent as the custodian.
Section 2503(e) Gifts
Since direct payments of tuition qualify for a special gift tax exclusion, one of the more common college saving techniques is saving in a separate account in the parent’s name.
The biggest one is its simplicity. It also gives the parent absolute control of the assets. Since the assets do not belong to the child, the savings account will not affect financial aid availability as negatively as it would if the account belonged to the child. If and when the child attends college, there are no gift tax issues because there is an exclusion from gift tax for transfers made directly to an educational institution for tuition in addition to the annual exclusion discussed above. Overall, it is a good solution for parents with a relatively modest estate for whom estate taxes are not an issue.
The drawback is that it does no gift or estate tax planning for the parents and any income on the assets will always be taxed at the parent’s top marginal income tax rate even after the child attains age 19.
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