Strategic Estate Planning: How Financial Planners Can Keep Their Client’s Estate Plan on the Right Track with their Education Savings Vehicles

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In looking just at schools ranked in the National Universities category, the average cost of tuition and fees for the 2020–2021 school year was $41,411 at private colleges, $11,171 for state residents at public colleges and $26,809 for out-of-state students at state schools, according to data reported to U.S. News in an annual survey. As a result, saving for college is the most significant savings goal of many families facing future college costs for their children, especially considering the depletion of portfolio and home values that occurred in 2008. Advisors who understand the various education savings tools and make appropriate recommendations while keeping a client’s estate plan intact, will bring significant value to their clients.

Uniform Gifts to Minors Accounts (UGMA) and
Uniform Transfers to Minors Accounts (UTMA)

From an investment standpoint, the simplest form of education savings vehicles, and therefore quite common, are an account created under the Uniform Gift to Minors Act (UGMA) or the Uniform Transfer to Minors Act (UTMA) in the child’s state.

Pros to clients:

1. UGMA and UTMA Accounts are easy and inexpensive to establish;
2. There are fewer restrictions as to what the funds can be used towards. Have your clients ever received a call from their college age kid wanting to go on spring break? Well now, there’s a fund with money ready for it! The accounts can be used for costs besides tuition or fees, like a car, or something not even related to education, such as a down payment on a house even. The custodian on the account can use them for anything the beneficiary needs until they reach the age of majority (18 or 21, as defined by state law).
3. You can transfer the funds to a 529 plan, provided the 529 plan will accept the UTMA/UGMA funds.
4. You can potentially transfer the funds to a trust for the benefit of the beneficiary if you are still acting as the Custodian.

Concerns from an estate planning perspective:

1. The beneficiary has the absolute right to the account upon reaching the age of majority (18 or 21, as defined by state law) and can spend this money however he or she pleases. Think back to when you were 18 or even 21. Most people that age are not making the best financial choices. For an immature beneficiary, the distribution and subsequent spending can cause problems. What if the parent does not want the child to have such easy access to funds at their state’s age of majority? This is where an estate planning attorney could help. They can draft different types of trusts (in a will or outside) that create age restrictions higher than 18 or 21 as well as special needs trust for children who are receiving needs-based government benefits.
2. Neither the custodian nor the donor can change the beneficiary after the account has been established. Until the beneficiary reaches the age of majority, the custodian has a fiduciary duty to spend the income or principal for the benefit of the minor.
3. While a transfer to a minor under UGMA or UTMA constitutes a completed gift for federal gift tax purposes at the time of the transfer, if the donor names himself or herself as custodian of the account and that person dies before the child reaches majority, the UGMA or UTMA account assets will be includible in the donor/custodian’s gross estate for estate tax purposes.
4. Another concern is if a beneficiary receiving needs-based government benefits, the required outright distribution may cause the loss of these benefits until the UGMA/UTMA funds are depleted.

Planning Tip: Upon learning that your client is contemplating an UGMA/UTMA gift or that your client is an UGMA/UTMA custodian, immediately discuss the potential problems with the client and possible alternatives for funding future expenditures for the child’s benefit.

Qualified Tuition Programs (529 Plans)

Under Section 529, states can set up two types of plans:

1. Prepaid tuition plans, through which the state guarantees tuition rates, will remain at current levels; and
2. Savings plans, which are essentially state-sponsored mutual funds.

Only cash contributions (checks, money orders, credit cards and similar methods) can be made to a Qualified Tuition Programs (QTPs). Contributions are not tax-deductible, but earnings grow tax-free and distributions are tax-exempt if used for “qualified higher education expenses” (QHEEs), which include tuition, fees, books, supplies, equipment, and room and board expenses.

Contributions qualify for the annual gift tax and the annual generation-skipping transfer tax exclusions. One of the most attractive gift tax features of QTPs is the contributor’s ability to “front-load” up to five years of gift tax annual exclusions (currently $15,000 per year, or $75,000 total) into the QTP in the first year and allocate to that year and four succeeding years. This allows the QTP funds to begin to grow tax-free while the donor removes up to $65,000 from his or her estate. (For example, this year for married couples with two children, they can remove $300,000 (2 x 2 x $75,000) from their estate instantly in one year if they make no other gifts to their children in the five-year window.) However, if the donor dies before the fifth year following the transfer, the annual gift tax and GST tax exclusions for years following the year of death are brought back into the donor’s estate for estate and GST tax purposes, so it’s important to keep that in mind.
Planning Tip: If the owner changes beneficiaries or effects a “rollover,” the account balance will not be subject to gift tax or GST tax if the new beneficiary is a member of the original beneficiary’s family and is assigned to the same generation (siblings and first cousins included). This can give the owner considerable power over an original beneficiary who is not inclined to pursue the higher education opportunity afforded him or her.

Planning Tip: A trust can be named as successor owner of the account, thereby ensuring that the assets are used in the intended manner, even if the original owner dies or becomes incapacitated. You’ll want to make sure to contact the client’s estate planning attorney to coordinate the correct language to be used so that an account follows a client’s estate plan.
Conclusion

Numerous options exist for funding educational expenses. As with most planning, no one option is best for all clients in every circumstance and often a combination of options will best meet the client’s needs and objectives.

One concern to keep in mind is that estate planning is important anytime there are minors involved. The main reason is estate planning attorneys want to prevent a guardianship because they are costly and time consuming. You can help your client not only save money but also reduce their risk by encouraging them to meet with an estate planning attorney.

Advisors who understand the educational funding options inherent estate planning concerns and, ask the right questions are in a position to provide great value and assistance to their clients in an area where there is great demand.