It’s no secret that the cost of a college education continues to soar. Jack and Debbie would like to help pay for their grandson’s higher education. They asked their estate planning advisor about strategies for funding their grandson’s education while saving gift and estate taxes. The couple’s advisor suggested three options:
1. Make direct tuition payments. A simple but effective technique is to make tuition payments on behalf of your grandchild. So long as you make the payments directly to the college, they avoid gift and generation-skipping transfer (GST) tax without using up any of your gift or GST tax exclusions or exemptions.
But this technique is available only for tuition, not for other expenses, such as room and board, fees, books and equipment. So it may be desirable to combine it with other techniques.
A disadvantage of direct payments is that, if you wait until the student has tuition bills to pay, there’s a risk that you’ll die before the funds are removed from your estate. Other techniques allow you to set aside funds for future college expenses, shielding those funds from estate taxes.
If your grandchild is planning to apply for financial aid, also be aware that most schools treat direct tuition payments as a “resource” that reduces financial aid awards on a dollar-for-dollar basis.
2. Create grantor and Crummey trusts. These trusts offer several important benefits. For example, they can be established for one grandchild or for multiple beneficiaries, and assets contributed to the trust, together with future appreciation, are removed from your taxable estate. In addition, the funds can be used for college expenses or for other purposes.
On the downside, for financial aid purposes a trust is considered the child’s asset, potentially reducing or eliminating the amount of aid available to him or her. So keep this in mind if your grandchild is hoping to qualify for financial aid.
Another potential downside is that trust contributions are considered taxable gifts. But you can reduce or eliminate gift taxes by using your annual exclusion ($14,000 per recipient; $28,000 per recipient for gifts by married couples) or your lifetime exemption ($5.34 million in 2014) to fund the trust. To qualify for the annual exclusion, the beneficiary must receive a present interest. Gifts in trust are generally considered future interests, but you can convert these gifts to present interests by structuring the trust as a Crummey trust.
With a Crummey trust, each time you contribute assets, you must give the beneficiaries a brief window (typically 30 to 60 days) during which they may withdraw the contribution. Curiously, the law doesn’t require that you notify beneficiaries of their withdrawal rights. Notification, however, is typically recommended.
If a Crummey trust is established for a single beneficiary, annual exclusion gifts to the trust are also GST-tax-free.
3. Consider a Section 2503(c) minor’s trust. Contributions to a Sec. 2503(c) minor’s trust qualify as annual exclusion gifts, even though they’re gifts of future interests, provided the trust meets these requirements:
Assets and income may be paid to or on behalf of the minor before age 21,
Undistributed assets and income will be paid to the minor at age 21, and
If the minor dies before reaching age 21, the trust assets will be included in his or her estate.
When the beneficiary turns 21, it’s possible to extend the trust by giving the minor the opportunity to withdraw the funds for a limited time (30 days, for example). After that, contributions to the trust no longer qualify for the annual exclusion, unless you’ve designed it to convert to a Crummey trust. Then, so long as you comply with the applicable rules, gifts to the trust will qualify for the annual exclusion.