Higher education is usuriously expensive. The fact that a child’s education may cost as much as you paid for your first house should highlight the importance of gifting these funds in the correct way.
You can pay an unlimited amount of money for a child’s education expenses, provided you pay the money directly to the educational institution. Qualified education expenses are looked at as a benefit to public policy, and therefore do not require the donor to fill in a gift tax return. The funds are also not deducted from your lifetime gift tax exemption, meaning you can continue to gift additional funds without having to assess a tax.
Paying a child back for their student loan payments is not the most efficient way of doing this. Remember that the exemption only applies if you pay funds directly to the educational institution. Tough having to pay off loans can often be a long-term educational experience in itself, a student loan company does NOT apply as a qualified education expense. Therefore, any payment you make to the student loan company or to the child paying the company may require you filling in a gift tax return (Form 709) to the IRS.
Another favorite of many people is funding a 529 Plan for a child’s education. This allows the donor to sometimes take a state income tax deduction, give the funds time to grow tax deferred, and have all funds withdrawn tax free is they are spent on qualified education expenses.
You may also choose to “front load” a 529 Plan with 5 years’ worth of annual exclusion gifts ($14,000 x 5, and twice that amount if you have a spouse), though remember you can’t donate any additional funds for the next 5 years). If the beneficiary of the plan does not go to school, the owner can change the beneficiary to another family member. And, if worst comes to worst and no family member ends up going to school, you can withdraw the funds for a tax and 10% penalty on the gain, which is not so good, but at least the funds grew tax deferred during the interim.
