With the cost of education only going up, many parents start saving for their children’s education long before their children will be attending college. Fortunately, there are tax-favored options that let you save in taxes while saving for college.
529 Accounts. Payouts from a 529 account used for eligible postsecondary education expenses are tax free. Eligible expenses include the cost of tuition, room and board, books, and supplies. States may impose varying limits on contributions, but most states allow a deduction for all or part of contributions made to a 529 account. However, there is no federal deduction allowed for contributions to 529 accounts. The account is allowed to grow tax-free until distribution. Additionally, if a child decides not to attend college or does not use all the funds in the 529 account, the account beneficiary can be rolled over to another family member to still retain the tax benefits. Also, contributions made to a 529 account are generally not included in the donor’s estate, offering an estate tax benefit as well. Grandparents can also make contributions to 529 Accounts, or even start their own for the benefit of their grandchildren.
Coverdell Education Savings Accounts. Like 529 accounts, distributions from Coverdell accounts are tax free if the funds are used for education expenses. However, unlike 529 accounts, funds from Coverdell accounts may be used to pay for K-12 education expenses, such as private or parochial education costs. There is an annual contribution cap of $2,000. A full contribution may be made by married couples with adjusted gross income of $190,000 less or by individuals with an adjusted gross income of $95,000 or less. Contributions are not tax deductible, but the amount in the Coverdell account grows tax free until distribution. Like a 529 account, any unused balance in the account may be rolled over to another family member to retain the tax benefits. Grandparents may also contribute to a Coverdell account, as long as they are careful that their contribution, combined with the parents’ contribution, does not exceed the $2,000 contribution cap. This can be especially beneficial if the parents’ adjusted gross income is too high, but the grandparents’ is below the maximum stated above.
§ 2503(e) – Tuition Paid Directly to School. Section 2503(e) provides another tax-favorable option for grandparents to help cover the cost of their grandchild’s education. Section 2503(e) states that payments of tuition made directly to the school are not considered gifts. Therefore, any payment made for tuition to a school will not have any gift tax implications – there will be no tax due even if the payment exceeds the $14,000 annual exclusion and the payment doesn’t count against the lifetime exemption amount.