Sending Your Kids To College - Educating Your Children |
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By: Ron Piner Posted: 2006-12-20 00:47:28 |
| What are parents to do in this financial climate in so far as educating our dear children? As always, the answer is right before our very eyes. We need only to look, listen, and seek knowledge that is understandable and practical. Welcome to my show and the MWIB series regarding financial studies. Please read and learn and be sure to ask lots of questions.For those of you who haven’t heard, the “kiddie” tax is extended to the age of 18 starting in 2006. This means that if a child has more than $1,600 of unearned income (interest, dividends, etc), he or she will pay tax at the parent’s top marginal tax rate. Prior to 2006, the age was children under 14. The strategy was to try passing income down to the children to take advantage of the lower tax rates to help with funding education. The kiddie tax prevents this from happening.To tell you the truth, I never thought much of this strategy anyway. I always keep my eye on the big picture leading my clients proactively through the mish-mosh of financial strategies. I feel the very same about the 529 plan. In the proper set of circumstances, the 529 plan works very nicely. If one happens to be quite wealthy, I think the 529 plan provides additional asset protection and wealth preservation when considering estate-planning issues. Because of one being wealthier, I think it is less troubling to me to duplicate strategies in a given portfolio. If one has a retirement plan along with a 529 plan, the investment strategies will be identical. This is unreasonable in my view, as middle income families can not afford to duplicate investment strategies. Instead, the middle income family is better off saving for education by adding to its portfolio outside of the retirement plan. This should be through a combination of tax exempt and high growth vehicles that will minimize tax consequences. By keeping excellent records and understanding such topics as the wash sale rules and capital gain and loss netting, one can further reduce exposure to income tax in the first place (see my article and instructional CD regarding capital gain and loss issues). I also think the 529 plan works for contributing grandparents.Enough about my thoughts regarding the 529 plan. Let’s talk about some other strategies for educating our children. What if the family owns a business? I love the idea of putting children on the payroll I really, really do. The catch is, the child should perform some service for reasonable compensation. Suppose your child is paid $5,150 in 2006. This just happens to equal the standard deduction. The parent’s business will gain a deduction and sonny boy will not have to pay income taxes because the standard deduction will reduce taxable income to zero. This money can then be used to build junior a portfolio for college. In addition, if the parent’s business is unincorporated and so long as the child is a minor, there will be no social security tax to pay. Man, do I ever love this stuff. Even when the kid reaches the age of majority, I like this strategy. In many instances, the adjusted gross income of the parents will be too high to take advantage of the hope and lifetime learning credits. In this event, paying our beloved offspring will provide us a tax deduction at the business entity level and will provide income for the student. Remember that wages paid must be reasonable for services rendered. The student will then file his or her own tax return taking use of the standard deduction and one of the educational credits. Notice that I did not mention exemption allowance. This is because the exemption is allowed only to the parent as they are providing support for the child. The parent will be giving up the exemption in order to give the use of the educational credit to the child. Remember that the parent has already gained a deduction by paying wages to the child through the business.What if there isn’t a business? In this case, my thought is for the parents to build their own portfolio using inside and outside retirement plan theories. Understanding capital gain and loss rules can help reduce tax exposure outside of the retirement plan and can allow for wealth building and having funds available for helping our children. The parents may be able to take the educational credits but can still pass it on to the child if tax planning dictates. The student may work while in school (a concept that has yet to kill any young student) and the educational credit could be of some benefit to he or she if the parent’s adjusted gross income is too high.Don’t be concerned about the extension of the kiddie tax. And don’t be overly enthused by the 529 plan. Follow my lead and provoke deeper thought into how to mange educating your children with the other aspects of portfolio building. Use all of your attributes to their maximum potential. Now really, don’t you think this article is well constructed and carefully contrived? I told you my way is better. |
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