Wills - Estates - Elder Law

If you watched President Obama’s State of the Union Address this past week, you would have heard him say that in the coming decade, two out of three jobs will require some type of higher education beyond high school. With the United States’ increasingly advanced workforce, there can be no doubt as to the necessity of education beyond high school in our modern economy. There can also be no doubt that the costs associated with such educational needs can be enormous and terrifying. If you’ve just had a child, consider this – the estimated costs of a four year private education in 18 years is projected to be above $360,000. Keep in mind, the median home price in Lower Burrell is about $120,000 (according to zillow.com). You’d have to mortgage your home three-times over just to send one child to college! Public education is not much better, with a projected cost of over $205,000.

With these figures in mind, what is a parent or grandparent to do?

Hope for education reform? With the current political atmosphere in Washington, you better not hold your breath.

Send your child to community college? A great way to save money, but community colleges usually only cover 2 of the 4 years needed for a bachelor’s degree. And it is likely graduate degrees will be necessary in the future for a real competitive advantage.

Pray for a scholarship? It’s a possibility and a blessing if it occurs, but they are not something that can be truly counted upon.

In the end, most parents turn to savings as a means to provide for their child’s higher education. There are several different worthwhile options to consider, each with their own benefits and disadvantages. This and the following article will discuss six different methods that parents and grandparents can use to start saving for their children’s college.

Traditional Savings Account

One method, all too common, is for the parents of a college-bound child to simply set up a new savings account, or continue to use their own personal savings account, to fund their child’s college savings account.

The benefits of using a traditional savings account are centered on the ease, simplicity, and flexibility of such accounts. If the parents are going to utilize their own personal savings account, there will not be any costs and efforts associated with creating a new account. If a new account is created, the costs and efforts are minimal. Additionally, funds in these accounts are not limited in what they can be used for, unlike other types of college savings accounts. Thus, if the child earns a scholarship or does not need all of the funds in the savings account, the funds can be used for other means. Further, if an emergency required the use of those funds, there would not be any penalties associated with using the money. Lastly, the assets remain in the control of the parents and do not have to be turned over to the beneficiary once the child attains a certain age.

There are several disadvantages associated with utilizing this method of college savings. First and foremost, there will not be the tax benefits that may be realized with other types of accounts. The income earned in these savings accounts will be taxed at what is likely the parent’s higher tax bracket. Nor will contributions to these savings accounts will not be deductible. In addition to the lack of tax advantages, the funds in these accounts would remain exposed to the creditors of the parents. The funds in these traditional accounts, owned by one or both of the parents, could be the subject of divorce proceedings or subject to probate were one of the parents to die.

While utilizing traditional savings accounts are cheap and easy to set up, there are other methods that are more likely to facilitate and promote the savings for the child’s college expenses. Therefore, other methods should be considered.

Uniform Transfer to Minors Act (UTMA)

Pennsylvania law allows for individuals to set aside funds specifically for the benefit of a minor child. These accounts can be set up at any bank or trust company by simply naming the beneficiary for the funds and a custodian. The custodian has control over the funds for the benefit of the beneficiary. Upon the child’s twenty-first (or in some cases twenty-fifth) birthday, the funds are to be turned over to the child/beneficiary.

Like a traditional savings account, the costs and time associated with establishing a UTMA account is minimal. There is a minimum threshold of income that (although low) does provide some tax savings, although this amount pales in comparison to other methods. Further, the funds in these accounts are no longer the property of the parents, and thus are immune from the parents’ creditors. Lastly, there are no restrictions on the use of the UTMA account funds (other than for the benefit of the beneficiary) and thus, do not need to be used exclusively for educational purposes.

The primary disadvantage of a UTMA account is that the funds in these accounts must be turned over to the beneficiary once they reach the age of 21 (in some cases 25). This can result in large sums of money being placed in the hands of someone that is: (a) not experienced in handling large sums of money, and (b) likely to make unwise choices. Further, in comparison to various other methods (such as 529 plan accounts), there are little tax benefits, and any substantial amount of income generated from these accounts will be taxed at the parent’s tax rate. Lastly, because these assets are technically the child’s, they can negatively impact the financial aid eligibility.

2503(c) Trusts

These accounts, the last that are considered in this article, are irrevocable trusts established in accordance with Section 2503(c) of the Internal Revenue Code.

The funds in these trusts are not subject to the same restrictions are those in a 529 plan account. For example, the funds need not be used exclusively for educational purposes. Also, the trustee is able to select from a greater range of investment vehicles than in a 529 plan account. Another advantage of the 2503(c) trust is that the assets can be placed beyond the reach of the creditors of either the parent or the beneficiary/child.

Because of the complexity of these trusts, an attorney is usually needed in order to draft the necessary documents. Additionally, they typically require more administration than a UTMA account, and thus are likely to incur more administrative expenses. While these trusts do provide some tax advantages (specifically the ability to make tax-free gifts), they do not produce the same tax benefits as a 529 account. Further, the assets in these accounts will be considered assets of the child and may negatively impact the child’s eligibility. Lastly, these trusts may require distribution to the child upon reaching the age of 21.

Next week’s article will discuss more advantageous vehicles for college savings, including Section 2503(e) accounts, Crummey Trusts, and, often the best choice, 529 plans.