Legacy Planning

Funding Education Expenses for the Next Generation: 4 Tax-Efficient Strategies

Funding Education Expenses

As the cost of college tuition continues to rise, many people are looking for ways to reduce these expenses. And if you’ve accumulated significant savings, you may be seeking tax-efficient ways to transfer your wealth to the next generation. Funding education expenses for your younger family members can be a great way to achieve both objectives. 

Taxes on Gifts

Unfortunately, gifting large sums of money to family members often comes at a cost. Currently, you can gift up to $16,000 annually ($32,000 per couple) per beneficiary without triggering the federal gift tax. The IRS also imposes a generation-skipping transfer tax (GST tax). This tax discourages people from deliberately skipping the next generation in their estate plan in favor of younger generations.

Indeed, these taxes can be a headwind for assisting younger family members financially. Fortunately, there are strategies you can use to transfer wealth without incurring a hefty tax bill—especially if your younger family members seek higher education. 

Consider these four tax-efficient strategies to fund education expenses:

Strategy #1: Fund Education Expenses Directly

One of the simplest ways to fund your family’s education expenses is to pay the educational institution directly. First, you’ll avoid gift and GST taxes. In addition, the amount won’t count towards your annual exclusion or lifetime exemption. 

Notably, this strategy doesn’t limit you to funding college-related expenses. You can pay for any level of education for your family members tax-free, so long as you write the check directly to the institution. 

Strategy #2: “Superfund” a 529 Plan

A 529 plan is an investment account that offers certain tax advantages if the funds go towards qualifying education expenses. Currently, you can contribute up to the annual exclusion amount each year without incurring the gift tax. 

In addition, many people don’t realize that you can contribute up to five years of gifts at once, per beneficiary. Meaning, in 2022 you can contribute up to $80,000 ($160,000 per couple) to a 529 plan at one time. That money can then grow tax-free until the beneficiary is ready to withdraw it.

It’s important to note that the tax treatment of 529 plans varies by state. To avoid unintended tax consequences, be sure to speak with your financial advisor before using this strategy. 

Strategy #3: Make Annual Tax-Free Gifts

If you can’t “superfund” a 529 plan, you can make annual contributions up to the annual gift exclusion limit tax-free. Alternatively, you can fund a Uniform Transfer to Minors Act (UTMA) account, an IRC Section 2503(c) Trust, or a Crummey Trust.

These accounts have similar benefits to a 529 plan but allow you to maintain more control over your gifted assets. However, these strategies can also be more complicated. It’s typically a good idea to consult a trusted advisor to determine what type of account makes most sense for you and your family.

Strategy #4: Lend Your Family Members Money

You may want to support younger family members financially without gifting them money outright. Instead, you can lend them money to pay for their education expenses.

Each month, the IRS releases Applicable Federal Rates, which represent minimum interest rates for family loans to avoid tax complications. These interest rates vary depending on the term of the loan. However, they’re typically more favorable than federal or private student loan rates. 

Funding the Next Generation’s Education Expenses

If you’ve been fortunate enough to accumulate significant wealth during your lifetime, you may be thinking about ways to pay it forward to the next generation. Since the IRS makes it difficult to transfer wealth completely tax-free, careful tax and financial planning can be beneficial. 

If you’d like to speak with a fiduciary wealth advisor about incorporating some of these strategies into your financial plan, please give us a call. We’d be happy to help. 

Teaching Kids About Money: 4 Tips for Wealthy Families

Teaching Kids About Money: 4 Tips for Wealthy Families

For high-net-worth families, teaching kids about money at an early age can go a long way towards preserving generational wealth. Indeed, financially educated children tend to make smarter choices with their money throughout life. However, there’s also an emotional component to inheriting wealth. Giving your children the tools to make good financial decisions includes instilling the right values and helping them develop a positive money mindset.  

Tip #1: Be Transparent…to a Point

Money is considered a taboo subject in many wealthy households. But there’s a fine line between transparency and oversharing. While your children may not need to know every detail of your financial life, bringing them into family conversations about money can be beneficial.

Teaching kids about money—specifically, how you accumulated your wealth and what wealth means to you—can impart responsibility and perspective. In addition, sharing positive stories about your family’s wealth can help your children develop a healthy attitude towards money.

Tip #2: Prioritize Financial Literacy

Many parents assume their children are learning about money in school. Unfortunately, this isn’t necessarily the case. In a 2019 survey of over 27,000 people, FINRA Investor Education Foundation found that four in five youths couldn’t pass a financial literacy quiz. One reason for this gap in financial literacy may be that only 18.4% of U.S. high school students must take a personal finance course to graduate, according to research from Montana State University.

When it comes to teaching kids about money, the responsibility still falls squarely on parents’ shoulders. If you don’t feel confident in your own financial knowledge, consider enlisting the services of a fiduciary financial advisor, who can facilitate family conversations about wealth.

Tip #3: Give Them Hands-On Experience

Often, children need to have some skin in the game to truly understand how money works. Paying them a weekly or monthly allowance is an easy way to give them hands-on experience.

In addition, consider creating an incentive system so they learn to save and invest—not just spend. Encourage them to set goals and schedule monthly check-ins to assess (and reward) their progress. 

Tip #4: Lead by Example

Lastly, make sure you practice what you preach. Regardless of what you teach your kids, they’ll notice how you behave when it comes to money. While none of us is perfect, we can all do our best to make smart financial choices for the good of our families. 

Teaching Kids About Money is an Ongoing Process

Teaching kids about money requires a healthy amount of patience, but the payoff is often worth it. Ultimately, you’re preparing your children to inherit, protect, and grow your family’s wealth, so it can be passed on to future generations. In turn, they’ll be better equipped to preserve the legacy you envision for your family.

Sherwood Wealth Management specializes in the financial planning needs of sudden wealth beneficiaries. If we can help you have these conversations with your children and plan your legacy, we encourage you to schedule an introductory call.