Taxes loom large in college savings choice

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Dear Dr. Don,
I want to establish an investment account for a new grandchild who lives in New Jersey. Is a New Jersey 529 the best route?
— Terry Tuition

Dear Terry,
The Bankrate site has a “Special considerations for grandparents” page in its College Savings 101 section. Here’s an excerpt:

Be sure to consider the benefits of a 529 plan. Many grandparents find it to be a particularly attractive investment program. Your ownership and use of the 529 plan to pay grandchildren’s college expenses has no impact on their eligibility for federal student aid under the current rules.

For grandparents, an in-state plan makes sense if the state offers a prepaid tuition plan and the grandchild reasonably can be expected to attend college in that state.

However, account owners who live in a state other than where the grandchild resides should always first consider the plan in the state where they reside if the state offers a tax deduction on the contributions. Compare the particulars of such a plan to the benefits in the child’s state of residence.

There is an alternative approach to consider — current tax law allows you to pay the tuition costs directly to the college or university. These payments don’t count against the annual exclusion for gift taxes and allow the grandparents to reduce the size of their estate.

No gift tax is imposed on a direct tuition payment, no matter how large it is. You could keep the money under your control and make the payments when the child is enrolled in college.

Remember to choose a strategy you can afford to replicate for all the grandkids.

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