Funding college: Save smarter
The only certainty is that the costs of higher ed are going up
We all know that the time to start saving for a child’s college education is at birth. This way, the
monthly hit to cash flow isn’t as bad as it will be if you wait until Junior matures a bit before
socking a few bucks away. But the reality is that life gets in the way, and this kind of savings plan
doesn’t work out too well for many Americans.
By John nApoli TAno
As financial planners, we frequently serve
those with the means and desire to fund their
children’s college education, and these clients
are hearing from every financial institution in
America looking to help them do this. I believe that many CPAs are uniquely positioned
to speak to their clients about the most effective way to save for their children’s education,
because issues of taxation and forecasts are
frequently a part of the discussion.
Before you go right to the advice part of the
education funding question with your clients,
ask some open-ended questions about their
desires and intentions with respect to college
funding. You’ll see that each client has their
own idea of the best way to do this. Some will
want to fully pay for anything and everything,
including a mediocre to poor outcome as a
student. Some will only fund the state university level of cost. And others will have strings
attached to the college funding equation,
such as matching funds from Junior for a part
of the cost, or limits on the numbers of years
or degrees they are willing to fund.
Once you get your client’s desires on the
table, the next step is to calculate how much
they need to fund, in whatever increments
your client feels are most achievable. Lump
sums or monthly contributions are the most
common methods. Clients whose compensation is bonus-driven may tie their contributions to their bonus schedule.
plete discretion by the trustee through attainable standards for distributions. This may give
the grantor an opportunity to foster whatever
values they would like to see passed down
the generations regarding education and
their experience as young adults receiving
higher education. Attainable or measurable
standards can be achieving grades above a
stated level, or volunteering at least a certain
stated number of hours for some period of
time to the grantor’s favorite charity. In effect, any value or intention of the grantor
can be worked into the language of the trust.
Perhaps this educational legacy is just the
incentive your wealthy clients need to take
advantage of the $5 million unified credit, as
it may be gone at the stroke of midnight on
Dec. 31, 2012.
COLLEGE VEHICLES
For clients who can make lump-sum contributions, the next issue is that of control
and the actual structure of the account. How
would your client like to control the funds? It
is still common for clients to open UTMA or
UGMA accounts in their children’s names for
John Napolitano, CFP, CPA/PFS, is chairman
and CEO of U.S. Wealth Management, in
Braintree, Mass.
college savings. This is my least favorite way
to save for many reasons. First is the complete loss of control of the money when Junior
turns 18 or 21. Junior will have the power at
that age to withdraw any funds remaining for
whatever they want — a sabbatical in Hawaii,
a Harley, or season tickets to the Dodgers. The
second part I do not like is that U TMA/UGMA
accounts are fully taxable each year.
Most common are 529 plans, where the
contributions are also made with after-tax
dollars, but the earnings accrue without current or future taxation if the funds are used
for college costs. Of course, you know that, as
well as the benefits of any local or state tax deduction available in your state. The state tax
reduction is frequently an enticer for clients,
regardless of how small the actual benefit
may be. For CPA financial planners with an
asset management division or outsourced
relationship, it is best to maximize the local
or state deduction amount first, even if that
plan may be unmanageable by you. Then you
can fund the balance into whatever other 529
plan meets your clients’ objectives that you
can manage for them.
The 529 is controlled by the account owner,
which can be the parent, the grandparent, or
anyone whom the person writing the check
designates as the owner of the account. This
owner decides if they want to use the funds
for college or not, with the child, who is the
beneficiary of the account, having no control
or access to the funds or the investment philosophy chosen. These plans are also somewhat portable, in that the owner can move
around benefits to other siblings or grandchildren or the original beneficiary. A planning strategy for the future will be moving
excess 529 plans from parents to new plans
for their children. 529s are still pretty young,
and there are not likely to be many 529 holders today who are also parents.
UTMA accounts can be rolled into a 529
plan and get the tax benefits of a 529. It will
not, however, cede control away from the
child when they reach the majority age of
18 or 21. As long as you have enough time
remaining until college starts, this may be a
beneficial move, regardless of the control issue, because of the tax benefits. There may be
capital gains from the sale of holdings in the
U TMA account, and that needs to be considered before moving a UTMA to a 529.
Another structural alternative would be a
trust. While the trust would not have the tax
advantages of a 529 plan, it may offer greater
control. Some trusts are specifically established for college education, and others are
by-products of other estate planning, where
children were tertiary or lower beneficiaries
of deceased parents and grandparents.
The controls that one can build into a trust
that is specifically designed to fund college
education can have any provisions or controls that are legal and that can be reasonably
administered by a trustee. There are a few
scenarios that I can think of where the trust
route may make sense. One is when a grantor
has reason to believe they will not survive the
child’s educational years, and they want to be
assured that the funds are used for that purpose. It makes even more sense if there are
no natural successors to the trustee role, and
some sort of professional trustee is needed.
Another good reason for a trust is for the
grantor who wants to endow a large family
and perhaps future generations for educational purposes. In one case I saw the “rich”
uncle, who wanted to exhaust his unified
credit in the days of the $1 million credit,
form an education trust for his nieces and
nephews, and any successor generations to
the extent that there were any funds remaining. Imagine how well this would work today
in the days of the $5 million exemption.
Some of the strings or conditions that a
grantor may include could range from com-
PREDICTING THE FUTURE
For those not looking to endow the generations, the next issue to tackle is that of how
much to fund and how to invest the amounts.
How much to fund is based on assumptions
that may or not come true. When coming up
with your assumptions for earnings on the
funds, it is important to listen carefully to
your client’s understanding of risk and what
level of volatility they are willing to accept.
The range of choices on how to invest college savings is limitless. Here the financial
advisor’s role is to help frame the assumptions based on the client’s feelings about risk.
If you have a risk-averse client, and that client is satisfied with a guaranteed 2 percent
rate of return on a certificate of deposit, then
you should forecast the amount they need to
save based on that 2 percent level of earnings.
Similarly, if your client tells you that they are
an investment guru, and asks you to assume
a 15 percent annual growth rate, you should
probably explain to them why this may not
be realistic or prudent.
In UTMA or 529 format, clients can use
products offered by banks, fund companies,
insurance companies, brokers or investment
advisors. In these structures of ownership,
you would be limited from owning any sort
of business interest, real estate or other nonregistered or non-banking product.
In the trust structure, the trustee can invest
in anything that the trust permits and that is
reasonable given the purpose of the trust.
Wide discretion may be advisable if this is a
very large trust. I suggest wide discretion because the investment world is changing, and
the trends in what institutions and wealthy
families own in their portfolios shift under
