Cut Your Tax Bill by Educating Your Grandchild

There is no better source of greater pleasure in life for aged taxpayers than spoiling their grandchildren by showering them with all kinds of gifts. The young ones too, seem to have some deeper connections to their grandparents than their own parents. With college education increasingly becoming expensive, the grandparents can chip in and at the same time, enjoy extensive tax benefits. There are several tax-friendly channels available for older taxpayers who desire to see their grandkids through college, by helping cover their college costs.

Qualified Tuition Programs-529 Plans

The prepaid tuition and college savings plans are the two types of qualified tuition plans.

Prepaid Tuition Plans

Also referred to as prepaid education arrangements or prepaid tuition programs, prepaid tuition plans offers families a way to beat rising costs of living buy virtually buying the projected future cost of education using the current prevailing rates. Sold in contracts or in units, these plans cover up a given number of year's tuition or a certain number of credits. These plans have the blessings of the state and avail a low-risk option for state-conscious donors with the desire to move large amounts of assets to their heirs without cutting their integrated credit. The withdrawal penalties and a relatively low return rate compared to other options, like college savings plans, are the main downsides of these plans. Moreover, these plans are only accessible by in-state residents and school alumni and may further be restricted to within-the-state public institutions. Some of these plans don't cater for the costs of private or out-of state schools.

College Savings Plans

Established by a state or eligible educational institution, college savings plans allows individuals to contribute towards the financing of the beneficiary's higher education. The contributions are made to a college saving account and the balance in the amount is determined by the performance of the primary investments. This eventually affects the amount of finances available to meet the recipient's education expenses.

Limits

All contributions build up on a tax-deferred foundation basis and earnings are tax free if a qualified education expense is used. Residents whom use their state's plan, plus a tax break for the rich taxpayers looking for ways to reduce their taxable estates, are offered tax deductions in most states. Contributors can accumulate to the limit of five annual gift tax exclusions on top of each year; this is stipulated in the qualified tuition rules. Up to $65,000 can be contributed by a single qualified tuition program in 2010 without creating a gift tax, provided the money does not exceed the amount necessary for the kids to finish their advanced education. Married couples can double that amount.

It is important to note that these limits are only applied per plan. You can contribute up to $120,000 to several different beneficiaries in a single year if you are a couple. The beneficiary is not necessarily expected to be a biological grandchild. In fact, it is not mandatory that the beneficiary be a relation of the contributor. An older couple can even opt to donate the amount to their neighbor's kid.

Disadvantages

The main set back of the qualified tuition programs is the penalty tax that any earnings included in any plan distribution not qualified for education costs is subjected to. Equally subjected to the same treatment are the nonqualified distributions which are handled as early distributions from retirement plans or annuity, which are both assessed a 10% early distributions penalty as well as counted as taxable income. However, the income and the penalty are only assessed on the earnings. A major factor for donors to think about is that any tax penalty only applies to the plan beneficiary and not the contributor.

U.S. Savings Bonds

Bonds, which are backed by the full faith and credit of the United States government, offer another ideal education sanctuary, preferred for the Conservative investors. This program permits tax exemptions of some types of bonds if the proceeds are channeled towards funding higher education expenses. Eligible under this program, is the interest realized in Series I bonds and EE bonds, Zero-coupon bonds and STRIPS, and Treasury inflation protected securities (TIPS). Series H and H are not eligible. For this exemption to apply however, there are a number of exemptions that apply.

i. Using the bonds to cover for a junior's higher education implies that the kid can only be a beneficiary and not the bond's direct owner.

ii. The child must be claimed as a dependent on the parent's or grandparent's tax return.

iii. Any eligible bonds must have been issued after 1989 to an investor who must have been at least 24 years old at the time of issuance.

iv. No single investor can purchase more than $30,000 of savings bonds (or $60,000 for couples) in a given year to be entitled to exemption.

Savings bonds provide a more elastic source of college funding than 529 plans if these conditions are met. This is because bonds are not subjected to a penalty in the event that the funds are used for a different purpose. On the other hand, the interest on the bonds then becomes taxable.

Coverdell Education Savings Account

Overhauled and stretched out in 2002, the Coverdell Education Savings Accounts were originally created as Education IRAs. These accounts allow a $2,000 an annual non deductible per child till they reach the age of 18. Provided the IRA is used for qualified education expenses, the earning grows tax-free, usually at the state and federal levels. When the beneficiary hits 30, the early distribution penalty and income tax are assessed on the earnings share of any amount left in the account for 30 days or more. There are some exemptions, like death or disability of the beneficiary, in which the early distribution penalty does not apply. Also, special needs beneficiaries are not subjected to the age 18 and 30 limitations.

The main distinctive feature between the Education savings accounts and qualified tuition programs is the integration of payments per child, just like the IRA contributions. The same beneficiary cannot receive contributions of $2,000 from four different family members in the same year. Furthermore, contributions are counted toward the gift tax exclusion. This implies that a fellow who contributes $2,000 for tax year 2010 to these plans can only apportion another $ 10,000 as a non taxable gift to a qualified tuition program for the same beneficiary.

The taxpayer's ability to benefit from education tax credits can be affected by the withdrawals from the accounts. The distribution and the credit cannot be used to cover the same expenses, irrespective of the recipient's ability to claim the credit in the same year that the distribution is made from the education savings account.

It is for these setbacks that these plans are less popular compared to other saving avenues, like the qualified tuition program