How to Make A Big Tax-Free Gift to Your Child or Grandchild

Anyone who has considered giving a substantial gift to a child or grandchild has to think about the potential consequences under federal law.  These could include the federal gift tax, estate tax and generation skipping transfer tax.  And we haven't gotten to potential state taxes yet, which don't necessarily work the same way as federal taxes.

But there's a simple workaround to all these taxes:  pay for your child's or grandchild's college education.  The burden of college loans is well-known.  If a student borrows $100,000 for college and/or medical, law, or other graduate school, and pays 8% per year over a 20-year repayment process, the interest costs actually exceed the $100,000 principal amount of the loan (by about $750).  If you contribute $100,000 to that student's education, you just in effect transferred over $200,000 to that student, all without any consequences under federal or state estate, gift or similar laws.  If the student potentially has to borrow larger amounts ($200,000 of educational debt is hardly unusual these days), the amount you can give tax-free to your child or grandchild increases proportionately.

Some parents think it's better to make kids bear the costs of college in order to teach them responsibility.  There are many ways to teach responsibility, and they should begin well before the child reaches college age.  If a kid isn't responsible by age 18, dumping a truckload of student debt on him or her isn't likely to improve the situation. 

If you can't pay the full cost of a kid's education, consider how much you can pay.  Whatever you provide reduces the potential need for loans, and the tax-free gift you give confers lifetime benefits on the kid.  And if you're not wealthy enough to face liability for gift, estate or similar taxes, remember that whatever amount of educational costs you cover still provides a large gift because the child might otherwise have to borrow the money and pay a lot of interest.  Even if you don't get to thumb your nose at the tax man, you give your kid a big lifelong hug and kiss.