Tax Tips
Qualified State Tuition Programs - Part II- March 2001
Richard Scrivanich - Partner
This month, we'll wrap up our discussion on how to save for college tuition. Since when we left off last month, we were in the middle of how you can use QSTP's (Qualified State Tuition Program's), let's first wrap-up other aspects of QSTPs that you should be aware of, before discussing other vehicles which can be used to help save for college tuition.
Contribution limits.
Section 529 does not impose contribution limits; it requires only that a QSTP have adequate safeguards to prevent contributions that exceed what the beneficiary may need for qualified higher education expenses. The proposed regulations provide a safe-harbor limit; the limit is determined by actuarial estimates and takes into account all tuition, fees, and other qualifying expenses that a beneficiary would have for five years of undergraduate enrollment at a qualifying institution with the highest cost. A qualifying institution in this case is one allowed under the specific state program. Some programs limit the total amount that can be contributed to the account, while other programs have annual contribution limits.
When determining whether to contribute to a QSTP, remember that it is the state program and not the account owner that determines how the funds are invested.
Estate and gift tax considerations.
For some, the best feature of QSTPs is the estate and gift tax treatment they receive. Generally, under estate tax rules, if the decedent names a beneficiary to certain assets but retains control over the assets, the assets will be included in the decedent's estate. However, a QSTP account can be controlled by the owner, while the value of the account is shifted from the owner's estate to the beneficiary and will not be included in the owner's estate. This feature can be a helpful estate planning tool. A grandparent who would like to fund a grandchild's college education, but does not want the child to have full control of unused funds, can use a QSTP.
QSTPs also get favorable gift tax treatment. A contribution to a QSTP qualifies for the $10,000 annual gift and generation-skipping transfer tax exclusion. An added plus: Donors can use a special election that allows them to treat a QSTP contribution as if it has been made over five years. This allows a donor to contribute up to $50,000 in year one to a beneficiary's account (subject to state limits), have it treated as if he or she had made five $10,000 contributions over five years, and qualify for the annual exclusion.
Other options.
QSTPs are only one way to save for higher education costs; other options include Education IRAs and Roth IRAs.
Education IRAs.
These IRAs must be created exclusively to pay the qualified higher education expenses of a named beneficiary, such as a child or grandchild. Generally, the earnings on the funds in the IRA won't be taxed until a distribution from the IRA is made, and distributions from the IRA won't be included in gross income. The annual contribution is limited to $500 per beneficiary, and can't be made after the beneficiary reaches 18. And you can't contribute to an Education IRA in the same year in which you contribute to a qualified state tuition program on behalf of the same beneficiary. Eligibility for Education IRAs phases out for single taxpayers with modified AGIs between $95,000-$110,000 and between $150,000-$160,000 for joint returns.
Note:
You can claim only one of the following for each student in any given year: the Hope Scholarship credit, the Lifetime Learning credit, and the exemption for the Education IRA earnings withdrawal.
Roth IRAs.
Roth IRAs are a great way to save for college, because withdrawals used to pay education expenses are excluded from the 10% excise tax on early distributions. Roth IRAs are also good because the withdrawals are first considered a nontaxable return of investment. This helps those who would like to use part of the Roth IRA to pay for college and let the earnings remain in the account to continue to grow for retirement. Another plus: The distributions at retirement are tax-free. The disadvantages to Roth IRAs are that the annual contributions are limited to $2,000, the contributor must have earned income, and eligibility is phased out for individuals with AGIs over $95,000 and for married couples with AGIs over $150,000.
Conclusion.
Paying for college can be a daunting financial task, but the burden can be eased with some careful planning early on. Using one of the QSTPs or IRA accounts can make saving for higher education easy and effective by letting parents or grandparents put aside money each year for higher education and reap certain tax benefits while doing so.
If you have any questions concerning using QSTP's or IRA's in order to help save for college tuition, please feel free to call me at (562) 698-9891.
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