Higher education has never had a higher price tag. Children entering college in the year 2012 can expect four-year tuition to be about $81,000 at a public university and $204,000 at a private university.
America's increasingly high-tech workplace is demanding better educated workers than ever before. Low-skill work is rapidly being replaced by automation, making a four-year degree a prerequisite for the vast majority of those positions that offer any hope for financial security and professional advancement.You need to take action now to ensure that your children (and grandchildren) have the basic educational requirements to survive in the 21st century workplace. Fortunately, there are a handful of financial strategies that help parents (and grandparents) do just that.
One of the most popular savings strategies is the custodial account, a separate account funded through the Uniform Gift to Minors Act (UGMA).
Custodial accounts offer considerable income tax savings and can help accelerate the growth of the child's college fund. Setting up the account is simple. Your child (or grandchild) is named as beneficiary of the account. Next, you name a custodian for the account who will oversee it until the child reaches the age of majority. Be careful, though. If you are both the donor and the custodian of the account, and you die before the child assumes control of it, the assets will be included in your taxable estate. The bank or other financial institution where you set up the account will give you advice about naming a custodian.
Each donor can transfer up to $10,000 to the custodial account every year gift-tax free. The child pays no income tax on the receipt of the gift. The gift also decreases the donor's taxable estate. Once the gift is made, income tax is based on the child's lower rate rather than the donor's higher rate. Because the greatest income-tax breaks come only after the child reaches age 14, many donors fund the custodial account with tax-free investments, such as bonds. Then, after the child turns 14, these assets can be sold and replaced with higher-yield investments where earnings will be taxed at the child's lower rate of 15 percent.
While the estate tax and income tax advantages with custodial accounts are enticing, these accounts have some disadvantages. Once the child (grandchild) reaches the age of majority, the assets legally become his or her property and can be used for any purpose, not necessarily a college tuition. The custodial account is considered an irrevocable gift. Once assets are given to the child (grandchild), the donor can't legally get them back.
Where the donor wants to make sure the gifted funds are used for college or other post-high school education, a fairly simple trust can be set up that accomplishes the goals discussed above, but prevents the child (grandchild) from using the money for non-education purposes.
For a child already in college, there's another attractive idea. Grandparents, or some other family member, can pick up the tab for the grandchild's higher education without triggering gift tax or using up the $10,000 annual gift-tax exemption. To qualify, the payments must be made directly to the college or university and must be for tuition. Room, board, books and other ancillary expenses are not eligible for this favorable tax-treatment. Of course, grandparents or some other family member can also give the child cash payments for those "ancillary" expenses as long as they fall under the $10,000 per person ($20,000 per couple) annual gift limits.
There's an additional solution for grandparents or other older family members who are concerned they may not live long enough to see a child's first day of college: Earmark assets that can help the child through college and put them aside in a revocable living trust for which he or she is a beneficiary. Your trust can be designed in such a way that upon your death, the child will receive an inheritance from you that can be used to fund a college education. To ensure that your legacy goes to pay college bills - and not a new sports car or Caribbean vacation - you can instruct your Trustee to manage the funds for your grandchild, right down to paying the college bills directly.
These are some of the gifting strategies that can help a child achieve that costly, yet priceless, college diploma. For more options, contact your estate planning attorney or other financial planning consultant.