Saving for Your Children’s Education

Posted by: cworrall on Monday, October 1st, 2007

Saving for your children’s education is an often talked about topic among parents. The newspapers are full of stories expounding on the rising cost of college. The financial aid system and rules are complicated, as are the savings and gift rules. In Maryland, not only is college a worry, but many Maryland children attend private schools whose tuitions also seem to be growing at an astronomical rate.

The Gift of Education

The Internal Revenue Code (IRC) provides for several gift options for the benefit of educating individuals. If your parents or other relatives have an interest in helping pay for your child’s education, they have a variety of options.

The first option is a gift. Currently, anyone may give anyone else up to $12,000 without incurring a federal gift tax. For example, should your parents choose to do so, they could give you, your spouse and your child each $12,000 per year, $36,000 in all.

The second option is to pay the school directly. Section 2503(e) of the IRC allows that anyone can pay a qualified educational organization for the tuition of another person without incurring a federal gift tax. This applies to public or private primary, secondary and preparatory schools, high schools, colleges and universities. This does not count towards the annual gift tax exclusion amount nor towards the lifetime exclusion amount.

Saving for College

There are two qualified state tuition programs (529 plans) in Maryland: (1) the Maryland College Investment Plan and (2) the Maryland Prepaid College Trust. The investment plan allows you to invest up to $250,000 per child for the payment of eligible college expenses. The prepaid trust is a contract with the state in which you agree to pay a certain amount each year to the trust and they guarantee that they will pay the full in-state tuition and mandatory fees at any Maryland public college (or the equivalent amount to any college of your choice); regardless of what the actual tuition may be at the time.

Anyone may open a 529 account for anyone else, so long as the maximum contributed per student is no more than $250,000. If you are a Maryland resident, you may deduct up to $2,500 per person per student, meaning if you are married with two children and each of you contribute the maximum to each child, you may deduct $10,000 for the purposes of calculating your state income. There is no restriction on age either and any amount that is not used for the benefit of the beneficiary may be used for the benefit of another family member. For instance, if your spouse plans on going back to school, you could open one for them. The earnings on the account will grow tax deferred and will become Federally tax free if used to pay eligible college expenses.

Different states have different rules as to the tax deductibility of the contributions. Check with your state to determine your tax deduction limits.

Education Savings Accounts

The Coverdell Education Savings Accounts may be established for the benefit of any child under the age of 18 to be used for qualified educational expenses, including public, private and religious elementary and secondary school expenses. No more than $2,000 may be contributed for any one child in any one year, but the distributions are tax free as long as used for qualified expenses.

If the beneficiary does not require the total amount for the qualified expenses, the remainder may be rolled over tax free to another account for a member of beneficiary’s family provided that individual is under 30. If the money is not rolled over, the remaining funds in the account will be distributed to the beneficiary when he or she turns 30 and will be taxable at that time.

Although saving for education can seem daunting, there are a number of investment vehicles that can provide opportunities for tax deferred or tax free savings. The complicated tax rules should not deter you from researching and selecting your best options. As always, you should consult your tax advisor to help answer specific questions regarding how tax laws apply to you and your children.

Topics: Individual, Investments