College Funding: More than 5-2-9

A child or grandchild
might go to college – start a 529 college savings plan. While this is probably
good advice for most, it’s not the only option. For many, it’s not the best
option. If you’re a physician, business owner or anyone worried about estate
tax or asset protection, there may be better approaches. Let’s review many of
the options for funding college costs:

529 College Savings
Plans: Contributions to these well known plans, named after the tax code
section that creates them, are not tax deductible, but the earnings escape all
income tax if the funds are used for college costs (tuition, room and board,
books). You can gift $12,000/year and even front load 5 years’ of contributions
at one time.  If you withdraw funds
for non-qualified expenses you’ll pay income tax on the gain and a 10% penalty.
Many states offer tax breaks for contributions to 529 plans. The recent
extension of the Kiddie Tax (taxes kids under a certain age at their parent’s
tax rate) to age 18 enhances the advantages of 529 plans over other options.

Coverdell Education
Savings Accounts: You can contribute $2,000 per child under age 18. While
you don’t get a deduction, and the maximum contributions are limited, these
funds can be used for any type of educational costs, including K-12 grades. 529
plans cannot. The ability to use this benefit is phased out when your income
reaches $220,000 (MFJ).

Direct Tuition Payments:
Benefactors can pay unlimited amounts for tuition costs if paid directly to the
institutions. For wealthy families already giving the maximum
$12,000/year/donee gifts, this is a great planning step as it doesn’t count
against these annual gifts. Grandparents looking to shrink their estates can
simply pay tuition as part of their gift program. If you have a durable power
of attorney be sure to authorize gifts in the precise manner you wish them to
be permitted. Name the permissible donees, the maximum annual gifts, and
whether direct tuition payments should be permitted. Permitting non-GST exempt
trusts to make distributions for grandchildren’s tuition (and medical) won’t
trigger GST tax. This can be a powerful addition to a child’s trust, by pass
trust, or other family trust.

Save in Your Name:  This non-plan can actually be a great
plan. You have total control over the investments and distributions. Funds you
hold may be counted less harshly for financial aid then funds in the students
name. While you can’t get the income tax break of a 529 plan, you can use tried
and true investment strategies (harvesting gains and losses, growth stocks with
negligible current dividends, etc.) to minimize income taxes. This provides no
asset protection or estate tax benefits.

IRA: You can
withdraw money from your IRA account without penalty if the funds are used to
pay for college and graduate school. This is probably the last option a student
should consider. It undermines a key savings plan for future retirement. The
withdrawals may constitute income that adversely affects your financial aid
efforts.

Get a Job-Employer Pays:
A great way to pay for graduate school is to get a job with an employer that
pays for tuition. A qualified employer educational assistance program can lets
you receive up to $5,250 tax free for tuition and other costs.

Save in Your Child’s
Name: This is typically in a custodial account. Recent tax law changes make
this costly for income taxes since income of a child under 18 is taxed at your
highest tax rate. Also, assets in a custodial account if you’re the donor and custodian
will be taxed in your estate. There is no control over the child’s misuse of
the funds.

Trusts: Instead of
putting assets in a child’s name where you might loose control, setting up a
trust to own the gift money for future education costs is a great way to
protect the assets. However, trusts create some complexity and are taxed at
higher tax rates faster than individual taxpayers. Trusts can own 529 Plans.
Trusts as part of an overall plan, however, might be the best option. See
below.

FLP/LLC: If you’re
setting up an FLP/LLC to consolidate family investments, protect assets,
minimize estate tax, coordinate investments, etc. instead of creating 529 Plans
consider setting up a trust for your children which will instead invest the
funds in your FLP/LLC. This can further support the validity of the FLP/LLC as
a family investment vehicle, fractionalize ownership, reduce your ownership,
and contribute to the entity being a more efficient family investment vehicle.
You won’t achieve the tax benefits afforded by a 529 Plan, but you may achieve
much broader and more important family goals.