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College savings plans and strategies are likely among the issues clients most frequently ask advisors about and that’s a good thing because this can be daunting subject matter.
Fortunately, advisors have tools with which to help clients bolster college savings, including 529 plans and Coverdell accounts. As a brief refresher, 529 plans feature several attributes that are likely attractive to a broad swath of clients, including tax-deferred growth, the ability to efficiently change beneficiaries, no federal tax implications and the ability to roll excess funds, up to $35,000, over into a Roth IRA.
The Coverdell Education Savings Account (CESA) functions differently in that annual contributions per beneficiary are capped at $2,000, but funds directed to these accounts can be used for more than college, including say private elementary or high school.
A CESA “is a trust or custodial account set up in the United States solely for paying qualified education expenses for the designated beneficiary of the account. This benefit applies not only to qualified higher education expenses, but also to qualified elementary and secondary education expense,” according to the IRS.
There are other education savings strategies for advisors to evaluate with clients.
Bad News, Good News
It’s a good thing advisors can offer up more than 529s and Coverdell because – and this is the bad news – college tuition has grown at exponential rates.
Proving that the real issue is what colleges are charging, not granting forgiveness on student loans, college tuition increased nearly 748% from 1963 through last year, on a currency inflation-adjusted basis, according to Education Data Interactive.
“College tuition inflation averaged 4.63% annually from 2010 to 2020,” notes the research firm. “The most extreme decade for tuition inflation was the 1980s, when tuition prices increased 121.4%.”
Chances are few, if any clients, salaries and investment portfolios matched or exceeded those rates of appreciation in comparable time frames. Fortunately, there are other college savings avenues, including the Uniform Gifts to Minors Act (“UGMA”) or the Uniform Transfers to Minors Act (“UTMA”).
With these accounts, advisors can add value for clients on multiple. First, many clients may not even be aware of these options. Second, there are differences UGMAs and UTMAs that many clients will likely need the help of a professional to understand.
“When referring to UGMA accounts to save for college, UTMA accounts may be brought up as well. Some people may use the names interchangeably, but there are slight differences between the two types of accounts. UTMA, or Uniform Transfers to Minors Act accounts allow gift transfers to minors outside of just cash and securities, and instead can include real estate, inheritances, and other physical property such as jewelry. Your clients may use UTMA accounts to save for college if they are available in their state,” notes Nationwide’s V. Gail Brannock.
Understanding UGMA Rules
Contributions to UGMA and UTMA accounts can be exempt from gift taxes to the tune of $17,000 per year, but as is the case with other tax-advantaged strategies, there are restrictions and rules for clients to be aware of.
In the case of UGMAs, the funds cannot be accessed until the beneficiary is an adult. That’s either 18 or 21 years, depending upon state laws. There’s more to consider.
“UGMA accounts are irrevocable, which means that once the adult makes a gift to the account, they can’t take it back. The assets in the account belong to the minor, not the adult,” adds Brannock.
Additionally, while a UGMA is tax-advantaged, it’s not tax-free. What that means is that if the funds are allocated to an investment portfolio, clients have to pay taxes annually on the income generated within the account.
“While they offer several benefits, it’s important for your clients to carefully consider the pros and cons before opening an UGMA or UTMA account. Based on their personal situation, a 529 plan, Coverdell ESA, or some combination of the three accounts may be the best option for your client,” concludes Brannock.
The point: UGMAs and UTMAs aren’t perfect, but they are potentially appealing to clients at a time when college costs know only one direction – higher.