For many families, contributing to a child’s education is equally as important as saving for retirement. Unfortunately, it is difficult to know, even tricky, which vehicle will help you the most. Generally, the best way to save is to contribute at least $200 to $300 each month to the investment vehicle you want to use as your child’s college fund. The earlier you save, the more the investment adds up and makes for an extraordinary plan. Here are a few vehicles available to families who want to contribute to a student’s future expenses that are compatible with most estate plans:
The 529 Plan
The first thing most families consider when planning to save for college is a 529 plan. A “NC 529 Program” (“529”) is a state sponsored savings plan designed to help families set aside funds for future college costs. There are advantages and disadvantages to a 529 that you should consider before choosing this plan. The biggest advantage is if the 529 is well-invested and properly managed over time, there is no tax on the gain inside the plan (similar to an IRA). The earlier you save, the more substantial the plan will be. The funds removed are tax free, so long as they are used for educational purposes. The beneficiary of the account can always be changed; so any money leftover can rollover to another beneficiary. The investment options for a 529 are improved and offer decent plans to fit various funding goals. However, the 529 doesn’t offer the state tax incentives anymore.
The disadvantages to a 529 plan reside in the loss of control of your money after it’s in the plan. Years ago the plan allowed state tax credits for contributions to a 529 but the legislature removed this in favor of lowering tax rates; now, contributions are recognized as gifts with after-tax money. Another downside to the 529 is once you put the money in the plan it is no longer your money. In essence, it belongs to the beneficiary. Any extra money in the plan rolls over to a new beneficiary but you cannot get the money back without a substantial tax penalty. You cannot name yourself as the beneficiary and, to the degree that your spouse is the beneficiary, the funds must be used for educational expenses or risk being taxed on the gain. A 529 plan also counts against the child’s assets when considered for need-based scholarships.
Uniform Gift to Minors Act Account
Another option is a Uniform Gift to Minors Act Account (“UGMA”). Unlike the 529 Program, this is not a plan; it is an account for gifting money for investment purposes to a minor child who isn’t old enough to take the money. A minor is any child under the age of eighteen. This is a terrible way to invest as a college fund; it counts against the child for any need-based scholarship. The advantage of a UGMA account arises in inheritance situations; for instance, in the event where a grandparent does not expect to see their grandchild go to college but wants to set aside some assets or money to help the child later on. The grandparent puts money into the UGMA account in a trust for the child’s future use.
There is no real advantage to a parent or grandparent in setting up a UGMA for educational funding. UGMA accounts offer no tax benefits or control of money once it’s in the account. There is no tax break for creating a UGMA account: you are still taxed as parents on the unearned income of your children and taxed on the earnings in the account. Typically, children get the money in the account at the age of eighteen and can use the funds for any purpose. The money is vested to the child, so you cannot get the money back or determine how the money is spent. Since the money belongs to the child, regardless of the purpose the child uses it, you cannot control it or get the money back.
The out-of-the-box solution to saving for a child’s education is purchasing a life insurance policy on the child that is structured for cash value buildup. This is not a normal life insurance policy. At first glance, this approach seems odd. But this isn’t the traditional policy structured for death benefit; this form of life insurance is a cash valued policy indexed to the stock market for tax free buildup inside the policy. The cost of the life insurance inside this policy is extremely low because it insures a young healthy child. This means that most of the premium payment is allotted to the investment; as you continue to pay, the cash value grows. Life insurance policies that are structured for cash value buildup, rather than death benefit, are great vehicles for educational funding. Most life insurance policies are structured for death-benefit; however most companies will restructure a policy for cash-value build-up. This plan is recommended for families where the parent or grandparent starts putting money back when the child is very young—after the child is six months old—and contributes at least $2,000 per year; better yet would be $6,000 each year for seven years. Just like other college plans, you’re using after-tax dollars; there is no tax credit or deduction. One big advantage with this approach for college savings is that none of the cash value in the policy is counted against the child or the parent for needs-based scholarships.
Payments must be made on the policy over time in order to be classified under the tax code as a life insurance policy; for instance, if you contribute a $50,000 one-time payment into the policy, the internal revenue service will not recognize it as a life insurance policy and hence does not work.
If structured properly with regular payments made over time, the plan becomes an educational fund with built-in asset protection. The money is protected from creditors, grows without taxes, and is removed tax free when the student borrows against it for educational purposes down the road. Also, like most life insurance, the death benefit is received tax free. If the student pays the money back to the policy, accumulating for sixty years or more, it becomes a fabulous retirement plan. It also negates any need for the child to purchase life insurance for his or her family needs. But just growing the insurance policy for eighteen to twenty years for college yields a good investment. If the child pays the money back, they’ll be paying themselves in the long run; it’s a gift that keeps on giving.
The bottom line is there are many out of the box solutions that help you to achieve your goals—whether it be for educational funding or retirement planning.
If you have questions about elder law, asset protection or retirement planning, consider W.G. Alexander & Associates – we are experienced attorneys who offer a unique blend of asset protection, Elder Law and estate planning. You can also attend our free seminars. Learn more through our website at www.wgalaw.com, or call us at (919) 256-7000.
Attorney Bill Alexander of W. G. Alexander & Associates discusses these issues and more every Saturday morning on his radio program, “Asset Protection Today,” on TalkRadio 680 WPTF (AM). Be sure to listen from 11:00 AM – 12:00 PM.