How Boomers Can Lighten Their Tax Load While Helping with Preschool Costs

Private preschools can be almost as expensive as state colleges. The cost of private colleges, by the time today’s preschoolers get to campus, can only be guessed at.

Here’s an opportunity for boomers to help their grandchildren attend the preschool of their parent’s dreams, while achieving some tax benefits, as reported in CNBC’s recent article, “Grandma to the rescue: The $20,000 way to cover preschool.” If the preschool qualifies, directly paying the costs could score you some major grandparent points and help with your estate tax burden.

One year of pre-kindergarten at a private elite school can cost thousands of dollars. Generous grandparents can pay these expenses and save on gift taxes. However, this takes some careful planning.

Grandparents can give money to their grandchildren in several ways, without being subject to gift taxes. First, you can make a gift up to the annual gift tax exclusion of $14,000 per recipient (or you and your spouse together can give away up to $28,000). You can also give money away under your lifetime gift tax exemption of $5.49 million, but whatever portion of this amount that you use in “taxable gifts” during your life, will decrease the amount you can pass to your heirs without an estate tax. If you are married, you and your spouse each are entitled to your own lifetime gift tax exemption of $5.49 million. Third, you can pay directly for the grandchild’s tuition or medical expenses, even it is over the annual gift tax exclusion. However, the payments have to go directly to the service provider.

When it comes to preschool, you need to prove to the IRS that your grandchild’s pre-kindergarten is educational. To qualify as a nontaxable gift, tuition payments to a preschool must be made to an “educational organization” as defined by the IRS. That means a regularly enrolled student body (no day-care) and the school must also have a regular faculty. A big issue with preschool is that it’s frequently considered custodial care, not educational.

If your grandchild’s preschool won’t qualify as an “educational organization,” but you still want to help them, consider these alternatives:

1. Pay for preschool, but stay under the limit;
2. Fund a 529 college-savings plan with a five-year front load, that’s up to $70,000 per beneficiary (the same as $14,000 annually for five years); or
3. Provide a low-interest intra-family loan, but talk to an estate planning attorney and draft a formal agreement with your adult child for this option.

All of these options, especially intra-family loans, do need the guidance of an estate planning attorney. After all, if you’re going to be generous, you’ll want to make sure to reap some of the rewards. You should also be sure to draft a formal agreement with your adult child, so there are no misunderstandings in the future.

Reference: CNBC (March 23, 2017) “Grandma to the rescue: The $20,000 way to cover preschool”