In a February 2001 interview, Rand Hutcheson, a lawyer in the Estate Planning Group at Rackemann, Sawyer, and Brewster, a Boston law firm, noted that, in general, you can pay a child’s or grandchild’s tuition free of any gift tax if you pay it directly to the educational institution involved.
This type of financial planning, called prepaid state tuition plans, allows parents or others to pay for a child’s future education at today’s tuition prices. Typically, these plans allow for tax-deferred growth of far larger sums than do educational IRAs.
- State tuition plans place no restrictions on how much a person can contribute, allowing for substantial sums to be set aside in a single year. Aformer college professor, Hutcheson succinctly explains the advantages and disadvantages of qualified state tuition plans under section 529 of the Internal Revenue Code (IRC) as follows. Advantages
- Annual exclusions: you can use up to five years’ worth of annual gift tax exclusions in one year. In other words, you can put $50,000 per child into a qualified state tuition plan ($100,000 for married couples who decide to split gifts) taxfree, as long as you do not make any other taxable gifts to the child for five years.
- Tax deferral: growth in the plan is not taxed until the funds are taken out, at which point the funds are taxed as ordinary income at the child’s income tax rate.
As of January 2001, qualified section 529 plans were available in forty-eight states, with most offering two types of investment programs: a prepaid tuition plan that lets you set aside money for your child’s college education at today’s rates (as explained earlier in this chapter) and second, a plan that invests your money in a managed portfolio of stocks, bonds, and money market funds.