Many parents and grandparents want to find ways to help the younger generations of their families. Fortunately, there are several tax-smart solutions for helping grandchildren and children.
1. Contribute to a 529 plan. Funds placed in this type of plan can be used for college costs without federal tax consequences. In some states, it is also possible to receive a break in income taxes for contributions. Plan members must usually contribute to their own state’s plan to enjoy a tax break from that state. However, some allow a tax break for contributions made to plans in any other state. Several states give tax breaks to anyone contributing, and there are others that only give breaks to the account’s owner. If this is the case, it is best for grandparents and parents to open separate individual accounts for children. This allows both parties to enjoy contribution deductions. Since there are no limits on 529 plans, children can have multiple accounts. To learn individual state rules regarding tax breaks, discuss them with an agent.
2. Use tax credits for tuition expenses. For those who are making tuition payments, the American Opportunity affords a generous tax credit. However, the student whose tuition is being paid must be in the first four years of college. The exact credit amount may vary from one year to another, so it is best to discuss the current number with an agent. Keep in mind that it is necessary to spend the maximum amount listed for tuition to qualify for the full credit amount. If less than the maximum tuition amount is paid, the credit will be less. There are also household income limits for these. Parents who want to claim the credit must also be able to claim the child as a dependent.
3. Obtain a 529 gift tax break. The maximum gift amount changes from one year to another, so discuss the current limit with an agent. Exceeding the gift limit amount will result in tax consequences. However, it is possible to make up to five years’ worth of contributions in one year without being subjected to that tax. In order to ensure the gift tax is not imposed, avoid giving the recipient any other types of monetary gifts within that period.
4. Assist grandchildren or children in contributing to a Roth IRA. There is no age minimum for a Roth IRA. However, contributors must earn income from a job. This means that children who have a job and are of legal working age can contribute. The job does not have to be based on a structured payroll. Lawn mowing, odd jobs and babysitting can also be counted. Kids may contribute up to the amount they earn each year. However, they must keep the contribution amount below the annual maximum. To learn more about this number, discuss it with an agent. Most young kids want to keep the money they earn, which means adults can contribute for them instead. They may withdraw all of the money without paying taxes after they reach age 59½. Current contributions can grow significantly over time, so this is a great way to give a long-term gift to children or grandchildren.
5. Provide children with a custodial account. While this type of account does not afford the same tax advantage as some other options, it is a valuable tool for teaching kids about investing. The money in the account can be used for anything that is beneficial to the child until he or she reaches majority age. When this happens, the child takes over the account. To learn more about contribution rules, discuss them with an agent.
6. Make tuition payments to the college itself. Any payments made directly to an educational institution are exempt from the gift tax. This benefit is afforded to anyone who makes a tuition payment, so grandparents or parents who want to help their children or grandchildren will not be subject to the gift tax. Keep in mind that this rule does not apply for room and board charges.