The cost ofcollegetuitionhas gone up significantly faster than inflation over the past several decades. iThe high price tag now associated with a college education makes it critical for families to carefully plan how to pay for higher education expenses. Part of this careful planning involves reducing tax liability—the more youpay in taxes, the less youwill have available for these other important expenses.Herewe discuss four especially tax-efficient ways to help your kids afford college.
Make direct contributions with a UTMA or UGMA custodial account
The Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) allow adult friends or family members to contribute to a custodial account on behalf of a minor child. While this accountremainsopen, the minor may take distributions only for certain permissible expenses, including education, support, and medical costs.
Meanwhile, the person who opened the UTMA account, or the custodian,retainsfull control over this account—at least until the minor turns 18 (or 21, depending on how the UTMA account is set up).
Some tax advantages of an UTMA account include:
Since the minor is the account's technical owner, any earnings on the account will not affect parents' or grandparents' income taxes.
Any gifts or contributions made to an UTMA account will qualify for the federal gift taxexclusion.ii
Get tax credits with a 529 college savings account
When it comes to reducing taxes whilesaving forcollege, itishard to beat a 529 savings account. Many states provide tax credits or deductions for 529 account contributions, and earnings on a 529 account are also tax free—that is,as long astheyareused topay forqualified higher education expenses. If your child does notexhaust their 529 funds by graduation, they can easily be shifted to another beneficiary—even a parent going back to school.
Consider placing tax-disadvantaged assets into an irrevocable trust
An irrevocable trust is a financial structure that allows you to place assets into a trust, but then they no longer belong to you. This can bea great wayto transfer assets that donot have preferential tax treatment. For example, if your top marginal rate is 37%, you can transfer funds that would be taxed atthis rate to an irrevocable trust. This reduces your tax burden while transferring the assets to an entity (the trust) likely to have a much lower tax rate.
Tap into a traditional or Roth IRA
A final way to create tax-efficient college savings is by withdrawing aportionof your traditional or Roth IRA. Although early withdrawal taxes and penalties normally apply to pre-retirement withdrawals, there are acouplekey exceptions for these types of IRAs.
For a Roth IRA, contributions can be withdrawn, tax- and penalty-free, anytime.iii
For a traditional IRA, funds can be withdrawn penalty-free to pay for qualified education expenses. However, you will still pay regular income taxes on anything youwithdraw.iv
Onecaveat: when using retirement funds to help pay for college, itisimportant to ensure you donotwithdraw too much. After all, your child can take out student loans, but you cannottake out retirement loans.
Important Disclosures:
The opinions voiced in this material are for general information only and are not intended toprovidespecific advice or recommendations for any individual security. Todeterminewhich investment(s) may beappropriate foryou, consult your financial professional prior to investing.
Prior to investing in a 529 Plan investors should consider whether the investor's or designated beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state's qualified tuition program. Withdrawals used for qualified expenses are federallytax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
The Roth IRA offers tax deferral on any earnings in the account.Withdrawals from the account may be tax free, as long as they are considered qualified.Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a10% IRS penalty tax. Future tax laws can change at any time and mayimpactthe benefits of Roth IRAs.Their tax treatment may change.
Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax inaddition to current income tax.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
LPL Financial Representatives offer access to Trust Services throughThe PrivateTrust Company N.A.,an affiliate of LPL Financial.
All information is believed to be from reliable sources;howeverLPL Financial makes no representation as to its completeness or accuracy.
This article was prepared byWriterAccess.
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