Q. I would like to set aside some money to help pay for
college education expenses for my grandchildren but I am
also worried about what will happen if my circumstances
change and I need the money for myself in the future.
It is often said that
education is the best investment that anyone can make. As
parents and grandparents we want to provide our children and
grandchildren with the opportunity to develop their talents
and skills to their fullest extent and encourage them to
“reach for the stars”. There are various planning
strategies that family members can use to help pay for
college education expenses, each of which has advantages and
disadvantages that must be evaluated based on the family
member’s individual circumstances.
One option is to
establish a trust for the benefit of your grandchildren to
pay for college expenses. You can establish and fund a
trust during your lifetime or you can include provisions in
your will that create the trust upon your death. A trust
created during your lifetime can either be irrevocable or
revocable. Funds that are transferred to an irrevocable
trust are gifts – once they are given they cannot be taken
back. A revocable trust allows you to retain full control
of your assets during your lifetime and provides for the
distribution of trust assets upon your death without
probate. However the assets in a revocable trust are not
protected from claims by your creditors. With any type of
trust you will need to consider whom you want to name as the
trustee to manage the trust, including alternate trustees in
the event the primary trustee is unable or unwilling to
serve, whether you want to have a single trust for all of
your grandchildren or separate trusts for each grandchild,
and whether the trust should be limited to educational
expenses or whether the trustee should have discretion to
make other types of distributions. You will also need to
include provisions that cover the possibility that a
grandchild does not attend college, becomes disabled, or
dies before the complete distribution of the trust. You can
name the trust, whether it is created by your will or
created during your lifetime, as the beneficiary of a life
insurance policy, brokerage account, or bank account.
A popular way to set
aside money for college expenses is to open a “Section 529”
college savings plan account for a designated beneficiary,
typically a family member, but any person can be named as a
beneficiary. Section 529 refers to the section of the
Internal Revenue Code that sets forth the requirements that
state-sponsored tuition programs must meet to quality for
favorable federal income tax treatment. Section 529 tuition
programs include prepaid tuition plans (such as the Michigan
Education Trust) and college savings plans. Michigan’s
college savings plan, the Michigan Education Savings Program
(MESP), is managed by TIAA-CREF (Teachers Insurance and
Annuity Association of America-College Retirement Equities
Fund) and offers state income tax advantages as well as the
federal tax advantages. There is a wealth of information on
the MESP website,
www.misaves.com .
Every state offers some type of
Section 529 plan and you are not limited to Michigan’s plan;
you can invest in any qualified state plan. Funds invested
in a Section 529 MESP account are not subject to federal or
state income tax on the earnings that accrue. If money is
withdrawn and used for qualified higher educational
expenses, those distributions will be tax free. Qualified
expenses include room and board (subject to certain
limitations) as well as tuition, fees, and books. If you
create a Section 529 account for a grandchild you still
retain some control over the account. You can change the
beneficiary on the account to another family member of the
beneficiary if, for example the original beneficiary doesn’t
use all of the money or doesn’t need the money. However if
you need to “cash out” the account or you simply change your
mind and want to withdraw the money for yourself you will
pay a 10% penalty and will owe income tax on the earnings.
You can name a contingent owner for your Section 529 account
who will automatically become the owner upon your death.
This will avoid probate of the account.
Some clients set up “in
trust for” accounts at financial institutions or brokerage
firms, naming a grandchild as the beneficiary, with the
intention of using the funds for the grandchild’s college
education. These accounts are essentially a revocable
trust. If you open this type of account you can freely
withdraw money during your lifetime. Upon your death the
account will pass to your named beneficiary who, assuming
he/she is over the age of 18, is then free to do whatever
he/she pleases with the money.
These “in trust for”
accounts are sometimes confused with accounts that are
created under the Uniform Transfers to Minors Act (UTMA
accounts). However an UTMA account is treated as a gift to
the minor which is held by a custodian for the minor’s
benefit. Usually the person who creates the account names
him/herself as the custodian. The custodian can withdraw
the money in the account but has a legal obligation to use
the money for the minor’s benefit. Furthermore, when the
minor reaches age 18 (or age 21 if this was specified when
the account was created), he/she becomes legally entitled to
the funds in the account.
The rapidly escalating
cost of higher education is making it more and more
difficult for families to pay for college education expenses
without incurring huge amounts of debt. If you can afford
it, helping your grandchildren with these expenses gives
them a gift that, if they use it wisely, will last a
lifetime and help them realize their dreams.