College Funding: Planning Ahead for Financial Security

In recent years, the cost of higher education has risen well ahead of inflation. At some private colleges and universities, the net cost for one year’s full-time education, including tuition, fees, and room and board, tops $40,000 (Trends in College Pricing—2013, The College Board). At these prices, the final cost of a bachelor’s degree from a private institution could exceed $160,000. In addition, with many professions requiring graduate degrees, it quickly becomes apparent that very few families may be able to cover education expenses with their current incomes. With only one child, the costs can be prohibitive; for families with three or more children, college and graduate school costs could easily be hundreds of thousands of dollars.

How can parents and grandparents build a fund for college? They need to look ahead and prepare a “blueprint” as early as possible, and there are a number of ways to do this. The best method will depend on the age of the child, the family’s resources and cash needs, and a number of other considerations.

No matter what the age of the child, there are legal techniques for placing money and property in a child’s name. Since it is generally inadvisable for minors to own property or have large bank accounts in their own names, gifts to minor children are usually made either to a custodian or to a trust.

The Custodial Account

While some of the tax advantages of a custodial arrang­ement have been affected by tax law changes, the technique is still worth investigating. It is the simplest method to give money or property to a child, involving very little paperwork, hassle, and legal fees.

All states have adopted either the Uniform Gift to Minors Act (UGMA), which authorizes a custodial arrangement for cash, bank accounts, and other savings vehicles, or the Uniform Transfer to Minors Act (UTMA), which allows the custodian to hold real estate and other property, including limited partnership interests. The laws of the state in which the minor lives will govern the account.

In many states, money or property held in custody must be transferred to the child at either age 18 or 21, depending on state law. Some states allow the custodian to designate the age at which the child may access the account, even beyond the age of majority. When the child has attained access to the custodial account, he or she may use the funds for whatever purpose he or she chooses, even if it’s not to pay for tuition.

Trust Benefits

Establishing a trust for a child may be more cumbersome and expensive than the custodial arrangement, but it may be desirable in some situations. One important reason to transfer property to a trust for the benefit of a child is to prevent him or her from “wasting” the funds. The money in the trust, whether it’s principal or income, must be used solely for the purpose for which the creator of the trust intended—the child’s education.

The creator of the trust may wish to use the Federal annual gift tax exclusion that allows individuals to give $14,000 (in 2014) each year to as many donees as they wish (or $28,000 if a spouse joins in making the gift). This exclusion only applies if the trust is structured to create a “present interest” in the child beneficiary. The present interest requirement may be used in a number of ways, some prescribed by the Internal Revenue Code (IRC), and some by case law.

Discretionary trusts can also be used. The trustee may accumulate income to take advantage of the trust’s 15% tax bracket or to distribute it to the beneficiary in a tax bracket that is lower than that of the trust.

Prior to making gifts or establishing trusts, the effects of either method on long-term financial goals and college savings programs need to be thoroughly assessed. Providing the best education for your child, while preserving the finances of the family, is integral to any decision.