Naturally, Uncle Sam takes an interest in college savings schemes. If you're thinking about making large gifts to your children, you need to keep the gift tax in mind. You can give each child up to $10,000 per year (a couple can give $20,000) without triggering the gift tax. The income on that money then will become the child's tax problem.
The tax rate the child will pay depends on age. Under current tax law, age 14 is the law's great divide. If a child is 14 or older, the first $500 in earnings is tax-free. Everything above that is taxed at the child's rate.
If a child is younger, the first $500 in earnings is tax-free and the second $500 is taxed at the child's rate. Anything above that is taxed at the parent's rate. Children who have jobs may be able to exempt a larger amount of income from taxes.
For most parents, the first step in saving for college should be to try to bring the child up to $500 a year in taxable income to take full advantage of that $500 tax exemption.
Additional taxable income also is desirable as long as it will be taxed at only the low 15 percent rate income tax rate. Once a child's income is high enough to be taxed at the 28 percent rate, tax-deferred and tax-free investments are better.