PENNSYLVANIA • NEW JERSEY • NEW YORK • FLORIDA
Saving for College and Estate Planning

Peter L. Klenk, Esq., J.D. LL.M. Tax

Your child may save you the cost of a wedding with a quick flight to Vegas, but there is little hope for a similar escape from the expense of college.

The expense of a college education continues to rise, putting pressure on you to develop a plan to cover the cost of your child’s education. Though many articles exist about investment choices when saving for education, most overlook the estate planning ramifications of the various savings vehicles. Your team of advisors should not only be examining the way to save money for your children’s education, but should also develop a plan to keep that money safe should you die prior to the money being spent on your child’s education.

When deciding on a method to save for your child’s education, seek the advice of not only your financial professional, but also your estate planning attorney and your accountant. These professionals all have a specific area of expertise that can help guide you to the proper choice of a savings vehicle.

There are several savings vehicles that may work for you:

  • A Lump-Sum Investment Held in Your Name: This approach requires you to put aside a lump sum amount of money early in your child’s life. This lump-sum amount is then invested with the goal of growing over time into the amount necessary to pay for your child’s college education. The calculation for how much must be invested will vary depending on your child’s age, the estimated cost of the college or university your child attends and how the lump-sum amount is invested. Your financial advisor can provide you with these calculations. The money can be held in your name in a separate account and all income will be reported to your social security number.
    • The advantages of this method are its simplicity and that it allows the money to be available for any use, not just your child’s education. Should you need the money yourself, it remains in your name. You are not making a gift, you are only putting aside the money under your own name.
    • The disadvantages are that, as the money is still in your name, it is available to your creditors, subject to the unknowns of divorce and should you die the lump sum…and all the growth it has generated…is part of your taxable estate.
  • A Lump-Sum Investment Held in An Irrevocable Trust: Instead of holding the lump-sum investment in your own name, your Estate Planning Attorney can create an Irrevocable Trust into which you give the money. After the gift, the Trust owns the money for the benefit of your child. The trustee invests the money just as you would have and has the ability to use the money for your child. The terms can be very flexible or specific.
    • The advantage of this method is that the money is now free from your creditors and free from complications of divorce. You no longer own the money…the trust does…so your creditors and spouse can no longer reach it. Another plus is that if you should die this money and all the growth it has created is not part of your estate. It remains in the trust, ready to pay the costs of education, an is not subject to estate and inheritance taxes. Furthermore, unlike other methods that require the money to be invested conservatively, the money can be flexibly invested and should your child not attend college, the money can easily be used for other things such as weddings, real estate or starting a business.
    • The disadvantages are that you have given the money away….it now belongs to the trust. You cannot use the money on yourself. There are also gift and income tax issues that must be addressed. Your estate planning attorney must explain to you the “Crummey Powers” (beyond the scope of this short article). The complications will depend on your specific circumstances. Your estate planning attorney should be consulted regarding whether this technique is right for you.
  • An Irrevocable Trust with Contributions over Time: Lets say you like the idea of the Irrevocable Trust, but don’t have the money to make the lump-sum payment. You can have nearly the same result by making regular payments to an Irrevocable Trust over your child’s lifetime. You will not get the same amount of growth as when you contribute a lump-sum early in your child’s life, but making contributions over time is less painful to you and the money you are able to contribute will grow to help pay the cost of college. Once contributed to the trust the money…and its growth…is sheltered from your creditors, divorce and, upon your death, will remain in the trust free of estate and inheritance taxes.
  • Custodial Accounts (UGMA and UTMA): Specifically created by congress to work around the Gift Tax and allow you to put money into your child’s name…but keep control away from them until age 21…the Uniform Gifts to Minors Act accounts and Uniform Transfers to Minors accounts are an inexpensive way to set college money aside.
    • The advantages of UGMA and UTMA accounts are that they are simple and inexpensive to set up. Your financial advisor can create an account in minutes.
    • The huge disadvantage of an UGMA or UTMA is that you have surrendered ownership of the assets and the child can do as he or she pleases with the money upon reaching age 21. I have seen many cases where parents have put large sums of money into an UTMA account when a child is young, only to discover as the child ages that the child will not attend college. The parents are then forced to turn over the money at age 21 to a child who may be a drug addict, mentally unable to protect the money, or is simply a bum. From an estate planning standpoint, if the parent remains the custodian than the UTMA account is included in the parent’s federal taxable estate at death. To avoid inclusion in the federal taxable estate, you must give up control to a third party.
  • 529 Plans: Also known as “Qualified State Tuition Programs” or “QSTP”, a 529 plan allows for income tax-deferred accumulation until the 529 assets are distributed. Withdrawals are then taxed to the student…but qualified withdrawals are free of federal estate taxes. Each state has its own 529 plan and your investment professional can assist you in deciding which state’s program is best for you. Your accounting professional can help you decide the income tax advantages of the various plans.
    • A 529 plan is a specific exception to the gift tax rules allowing you to make a gift that qualifies for the annual exclusion to the Gift Tax while limiting a child’s access to that money. Further gift tax exceptions allow you to bundle together in one year a total of 5 years worth of gifts that qualify for annual exclusion. Your estate planning professional can help you decide if, given your circumstances, such a gift is advisable.
    • The principal disadvantage of the 529 is that, once again, you have given away the money. Though there are exceptions that your financial advisor can explain in more detail, you have also given up the ability to use the money for your child other than education.

Though several different techniques exist to help you save for a child’s education, you should carefully examine the options with your accounting, financial and estate planning professionals. Your given set of circumstances and your desire for flexibility in investing, avoiding estate and inheritance taxes and in determining when (if ever) the child has unfettered access to the money will dictate which technique is best for you.