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Published: 2008-03-26

Estate Planning Helps You Pay for Education



Naturally, you want nothing but the best for your children and grandchildren, and getting a good education is a big part of that. Fortunately, the law helps you provide for their education - and also saves on taxes.

Estate Planning and Education

Besides providing a blueprint for how you want to take care of your loved ones - and yourself in the event of disability - estate planning can assure that the young people in your life have the quality education they'll need to succeed in this high-tech world.

Because Uncle Sam knows how important education is to our society, the federal government has come up with a variety of ways for you to receive tax breaks while meeting educational expenses. Your lawyer can advise what would be best in your particular situation, but here are some of the many possibilities to choose from.

Paying Educational Expenses through Life Insurance . Life insurance is an important estate-planning tool. You pay a relatively small amount up front, and your beneficiaries get much more when you die. You can use life insurance proceeds to set up a college fund for your children or grandchildren.

This works especially well if you have the funds paid into a life insurance trust. By establishing such a trust for the benefit of minor children, you can avoid the expense and court involvement of having a guardian manage this property. By having the proceeds paid to a trust, the trustee you name will have control over it.

And there can be important tax savings to using this approach if you are careful to see that the policy is not in your name. If you own the policy directly and it is in your name, the proceeds payable on death will be included in your estate for tax purposes, and that might force your estate to pay taxes if it is larger than the current floor of $650,000. However, if you arrange that someone else owns it - such as an irrevocable life insurance trust - the proceeds aren't included in your estate, and pass tax-free.

Other Trusts . Of course, you can use trusts to insure your children's education even if you don't fund them with life insurance proceeds. Trusts in general offer the great advantage of not requiring you to give your children or grandchildren gifts outright. They allow you to direct how the funds will be used, under the management of a trustee you choose. Your trust can be set up to pay educational expenses in a wide variety of ways. For example, your trust can provide that funds are to be used for tuition and related expenses while the child is in college, with remaining sums to be used for graduate school or to be distributed to the beneficiary at a later age. A generation-skipping trust is particularly appropriate for assuring the education of grandchildren. These versatile trusts enable your family to use the money for college costs, medical expenses, large purchases, such as homes, and general support. They avoid or limit estate taxes on the estates of your children and enable you to put in as much as $1 million ($2 million for a couple) that will pass tax-free. That sum can grow in the trust beyond that amount - through investments and interest - and still pass tax-free.

The "Gift" of Education . Here's another possibility that is of particular interest to grandparents. If your estate at death totals more that $650,000 (and you haven't arranged a generation-skipping trust or other trust to lighten the load), the estate is liable for hefty taxes, with rates starting at 37% and going as high as 55%. One way to reduce this tax burden is to pay certain expenses before your death. You can make tax-free, direct payments of tuition expenses for private or parochial schools as well as college and graduate school. Any funds paid directly to the educational institution will not be liable for gift taxation.

IRAs. A wide range of Individual Retirement Accounts (IRAs) can help you save for education - and save on taxes.

The new Roth IRAs let you put in up to $2,000 of after-tax money a year ($4,000 for a couple). Your money then grows tax-free as long as certain conditions are met. As long as you withdraw money for a college education for yourself, children, or grandchildren, you can make withdrawals with no penalty before age 59.

Proceeds of regular IRAs can be used to pay for college or graduate school with no withdrawal penalty, even if the sums are withdrawn before you turn 59.

Education IRAs enable you to put away up to $500 per year for your children's education, and you're not taxed on any gain. Unfortunately, the amount is low and there are many conditions. Still, these IRAs could be one piece of your plan.

The new Hope Credit and Lifelong Learning Credit enable you to reduce your taxes by up to $1,500 and $1,000 a year respectively if certain conditions are met.

The States Can Help Too

State governments have also set up mechanisms to help you pay for the college education of your children while saving money or taxes. Alternatives available in some states include prepaying tuition to state colleges (you pay at today's costs for tomorrow's education). Almost every state has set up so-called 529 Plans (named for a Section of the Internal Revenue Code). These let you invest in education bonds that mature when you need them or set up other programs that let your investment be tax-deferred until you withdraw it.

Many Possibilities

All in all, the law has given you many alternatives to explore. Contact your lawyer to see which is best for you.