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Gifting for Graduation? Consider College Savings Plans!

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With graduation season upon us, you may be considering a gift to help with the costs of higher education.  While most students would like the idea of a direct cash gift, one of the best ways to gift is through a qualified education savings plan.  There are a variety of plans to use for college savings, but we’ll be focusing on Section 529 Plans and Roth IRAs in this post.

For those considering a significant cash gift to a high school senior, keep in mind that financial aid for college is dependent in part on the assets owned by the child.  Since 20% of assets owned by the child are factored into the expected family contribution (EFC) on the FAFSA form, a cash gift could significantly reduce the financial aid offer by the college.

Alternatives to cash gifting include the use of different types of savings plans.  The most popular college savings plan, the Section 529 Plan, allows for tax-deferral and tax-free withdrawals for qualified higher education expenses.  If the plan is in the name of a parent, the account balance will only count up to 5.64% for the EFC, after an asset allowance.  As an example, 50-year old parents get an allowance of $46,6001 for 2013.  If their non-retirement assets are below the allowance, the monies held in the 529 Plan on behalf of their future college student won’t factor into the EFC.

In tax year 2013, gifts up to $14,000 ($28,000 if married) per year can be given to any recipient without requiring the donor to file a gift tax return.  A special provision that applies only to 529 plans allows for a 5 year advance into the account  without triggering gift tax, allowing an individual to gift up to $70,000 lump-sum to jump-start a plan.  Married grandparents wanting to reduce the value of their taxable estate often use this strategy to gift up to $140,000 per student and remove assets from their estate.

Contributing to a Roth IRA in the student’s name is an alternative to the 529 Plan.  However, unlike 529 Plan, the student must have earned income to qualify for Roth contributions.  If the student has employment earnings, the Roth can be funded up to the amount of their earnings.  Because Roth IRAs are considered retirement assets, the value of the account won’t be factored into the EFC.  In addition, if the student needs to use the funds for educational purposes, withdrawal of the principal is tax-free.  The earnings are subject only to ordinary income taxes and escape the early-withdrawal penalty when used for higher education costs.  It is important to note that if the funds are used while in college, withdrawals could count as income for financial aid purposes.

The options for giving and saving for higher education are numerous, and each option comes with its own benefits and drawbacks.  Use a Certified Financial Planner™ to help draft a custom savings plan to meet education funding goals.

1.US Department of Education EFC Formula: http://ifap.ed.gov/efcformulaguide/attachments/082511EFCFormulaGuide1213.pdf

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