The Pillars of Education Planning
Craig Hackler, Financial Advisor, Raymond James Financial Services
While control may be an
important factor, other aspects such as
investment flexibility and the taxation of
those investments should also be
considered.
An ever-stressful topic among parents
is how to accumulate sufficient
resources to meet their children’s
education funding needs. Ideally, the accumulation
of resources for education costs
should be based on an investment strategy
that incorporates fundamental investment
planning principles. Before an investment
strategy is formulated a parent may wish
to address four basic issues that may be
critical to successful planning:
1. control of investment assets,
2. investment flexibility,
3. investment taxation,
4. financial aid concerns.
A sound first step is to address the question
of who wants control of the assets. If
the parent is not comfortable with giving
up control of the investment assets that
are going to be put aside for their child’s
education, investments where the parent
retains ownership should be explored. A
529 college savings plan may be a consideration
since the account owner of a 529
plan, which is usually a parent, is in control
for the life of the account. While the
child benefits from the account, the child
never gets control of the account, even at
age of majority. A regular investment
account owned by the parents could also
be used to save for education. The parent
keeps control of the assets and this may be
what is most important.
If, on the other hand, the parent has no
reservations transferring assets into their
child’s name, then this can be easily
accomplished by utilizing an
UGMA/UTMA account. This, of course,
comes with the understanding that if their
child fails to go to college and instead
wishes to become an avid European backpacker,
it is the child’s money and he/she
can do with it as he/she wishes upon
reaching the age of majority. Remember
that all transfers (gifts) to a child via an
UGMA/UTMA account are irrevocable
and the parent needs to be aware that this
really does mean non-changeable.
While control may be an important
factor, other aspects such as investment
flexibility and the taxation of those investments
should also be considered. For
example, in a regular investment account
which the parent completely controls,
there is great flexibility in what the
account can be invested in, but those
investments will be taxed at the parent’s
higher tax rate. Like the regular investment
account, a 529 plan offers control
but also offers additional tax advantages,
such as tax-deferred earnings within the
account with the possibility of federally
tax-free* withdrawals for qualified higher
education expenses. However, there aren’t
as many choices when it comes to selecting
investments.
With UTMAs/UGMAs, the child may
obtain control of the account at age of
majority, unlike a regular investment
account. However, the way the account is
taxed is more advantageous.
UTMAs/UGMAs are taxed according to
the ìkiddie taxî rules. For children under
age 18, the first $850 of unearned income is
tax-free, and the next $850 is taxed at the
child’s rate which is most often 10%. All
investment income over $1,700 is taxed at
the parent’s tax rate which could be as
high as 35%.
Beginning in the year the child turns 18,
however, the child’s unearned income is
taxed at the child’s rate. Thus,
UTMAs/UGMAs can be used as part of a
strategy to shift unearned income to the
child beginning in the year the child turns
18 in order to take advantage of what
might be as much as a 25% tax bracket differential
(35% vs. 10%). From a practical
standpoint, with the child reaching the age
of 18, the parents may start to get a good
indication of what type of child they have,
studious or European back-packer, and
may be more comfortable in making the
decision to transfer assets at this point.
Finally, weighing education savings
options is beneficial to determine whether
a parent with a college bound child
intends to apply for financial aid, and if
so, how assets owned by the child will be
treated by colleges and universities during
the financial aid needs review. Typically,
35% of assets held in the child’s name may
be deemed available to meet education
expenses while 5% to 6% of the same
assets may be deemed available if owned
by the parent. The net effect may be
potentially less financial aid for the child if
assets are held in the child’s name. While
UTMAs/UGMAs are considered assets of
the child for financial aid purposes, 529
college savings plans and regular investment
accounts are more advantageously
counted as an asset of the parent if the
parent is named as owner on the account.
Having an understanding of the “pillars
of education planning” provides for a solid
foundation from which to analyze education-
funding decisions. Of course, this
brief article is no substitute for a careful
consideration of all of the advantages and
disadvantages of this goal in light of your
unique personal circumstance. Before
implementing an education planning
strategy, contact and consult with your
financial advisor.
* Withdrawals for qualified education
expenses became federally tax-free effective
January 1, 2002.
Craig Hackler holds the Series 7 and Series
63 Securities licenses, as well as the Group
I Insurance license (life, health, annuities).
Through Raymond James Financial
Services, he offers complete financial planning
and investment products tailored to
the individual needs of his clients. He will
gladly answer your questions. Call him at
512.894.0574 or 800.650.9517
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