Planning and Paying for College
Volume 2 • Issue 2 • February 2012
The Counselor is a monthly newsletter of Hallock & Hallock dedicated to providing useful information on estate planning, business succession planning, and charitable planning issues. This month's issue will highlight several educational savings tools to discuss with your advisors. If you are interested in learning more about the ideas and processes discussed in this newsletter, please contact us for an initial consultation.
With higher education costs outpacing inflation by 5-6% per year and the average cost of a four-year public school at nearly $20,000 per year (double that for private schools), it’s no surprise that many parents and grandparents are deeply concerned about how they will pay for higher education. Financial aid is always an option, but a recent article in Bloomberg warned that student loan debt could be the next bomb to rock the U.S. economy. What follows is a brief look at several tools available to pay the cost of education.
Uniform Gifts to Minors Accounts (UGMA) and Uniform Transfers to Minors Accounts (UTMA)
The simplest form of education savings vehicles, and therefore quite common, is an account created under the Uniform Gift to Minors Act (UGMA) or its successor, the Uniform Transfer to Minors Act (UTMA) in the child’s state. While easy and inexpensive to establish, there are considerable disadvantages to these types of accounts, including the child’s absolute right to the account upon reaching the age of majority (18 or 21, as defined by state law) to spend this money however he or she pleases.
Under Section 529, states can set up two types of plans:
Prepaid tuition plans, through which the state guarantees tuition rates will remain at current levels; and
Savings plans, which are essentially state-sponsored mutual funds.
Only cash contributions (checks, money orders, credit cards and similar methods) can be made to a 529 Plan. Contributions are not tax-deductible, but earnings grow tax-free and distributions are tax-exempt if used for “qualified higher education expenses” which include tuition, fees, books, supplies, equipment, and room and board expenses.
One of the most attractive gift tax features of a 529 plan is the contributor’s ability to “front-load” up to five years of gift tax annual exclusions (currently $13,000 per year, or $65,000 total) into the 529 in the first year and allocate to that year and four succeeding years. This allows the 529 plan funds to begin to grow tax-free immediately.
Another great benefit is the ability to change a beneficiary. This can be a great benefit if the original beneficiary is not inclined to pursue higher education.
Coverdell Education Savings Accounts (ESAs)
ESA funds are to be used for qualified education expenses. Contribution amounts are more limited than 529 plans and must be made in cash and cannot be made after the beneficiary reaches age 18. The beneficiary’s parent or legal guardian controls the account (regardless of who makes the contributions) until the beneficiary attains the age of majority. A change of beneficiary is tax-free if the new beneficiary is a member of the prior beneficiary’s immediate family or a first cousin. Contributions constitute a completed gift for gift tax purposes. For estate tax purposes, funds in an ESA are “owned” by the beneficiary and are includible in the beneficiary’s gross estate, not the donor’s
A cash value whole life or universal life insurance policy generally gives its owner the option of borrowing against the policy’s cash value. Policy owners may therefore take tax-free withdrawals and tax-deferred loans to pay educational expenses (or for any other use), while the cash value build-up continues to grow tax-free. If the policy continues until death, the income tax-free death benefit will repay any policy loans and the policy’s beneficiaries will receive the remaining net death benefit. In the event of premature death, the life insurance benefit can complete the planned education funding.
A variety of options exist using the power of trusts. Options include the 2503(c) minor’s trust; a Demand (Crummey) Trust; or a Health and Education Exclusion Trust (HEET). Each of these options has very specific requirements that must be followed. With proper planning, they can provide a vehicle that not only provides funds for education, but also provide powerful estate planning possibilities.
Impact on Financial Aid
Whatever strategy you choose, it is important to consider the impact on financial aid eligibility. According to FAFSA’s 2011-2012 Application and Verification Guide, the need-based financial aid rules state that 12% of the parent’s assets and 20% of the child’s assets are available for education. Therefore, shifting assets from the parent to the student through the use of UGMA/UTMAs, ESAs and 529 plan distributions may reduce the student’s need-based financial aid. Alternatively, life insurance should not impact need-based aid, whereas a demand trust may, depending upon the child’s access through the trust terms.
Numerous options exist for funding educational expenses. Careful, individualized planning can help make sure you choose the options that will work best in your situation. Because some of the choices include complicated tax decisions you should consult with qualified advisors to assist in your decisions.
This Newsletter is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.