Saving for Your Child’s Future: 3 Options to Consider
19 May 2021Sean Angelis
A parent’s desire to give their child the best possible chance to succeed in life is one that transcends language, culture, and political affiliation. For many parents, this means providing their children with monetary support for some of life’s big-ticket items, including college tuition, a down payment for a house, or even a wedding. There are a myriad of strategies to save for your child’s financial future, but three options stand out for their tax benefits and asset control: 529 plans, Uniform Transfers to Minors Act and Uniform Gifts to Minors Act (UTMA/UGMA) accounts, and irrevocable trusts.
A 529 plan is a tax-advantaged savings plan used to pay for qualified education expenses. UTMA/UGMA accounts allow parents to save and invest for the benefit of their children while maintaining control of the assets until their children reach adulthood. Irrevocable trusts can also be used for these same purposes, while giving parents greater control over when their children can access the funds. The table below shows the basic attributes of each option.1
Year 2021 Rules
529 Plans
UTMA/UGMA Accounts
Irrevocable Trusts
Federal Gift Tax Treatment
Contributions treated as completed gift; apply $15,000 annual gift exclusion or up to $75,000 with 5-year election
Transfers treated as completed gift; apply $15,000 annual gift exclusion
Transfers treated as completed gift; apply $15,000 annual gift exclusion if terms of trust qualify gifts as present interest gifts (Crummey power)2
Federal Estate Tax Treatment
Value removed from donor’s gross estate; partial inclusion if donor dies during the 5-year election period3
Value not included in donor’s gross estate unless donor remains as custodian
Not included in grantor’s estate
Maximum Investment
Established by the program; many in excess of $400,000 per beneficiary
No limit
No limit
Qualified Expenses
Tuition, fees, books, computers and related equipment, supplies, special needs, and some room and board at eligible colleges and universities; costs of apprenticeship programs; up to $10,000 per year in tuition expenses at private, public, and religious K-12 schools; up to $10,000 in student loan payments for the beneficiary and each of the beneficiary’s siblings
Not applicable
Not applicable
Able to Change Beneficiary?
Yes, the plan beneficiary can be changed to another member of the beneficiary’s family
No, the account represents an irrevocable gift to the beneficiary
Terms of the trust govern
Time/Age Restrictions
None unless imposed by the program
Custodianship terminates when minor reaches age established under state law (generally 18 unless extended to 21)
Terms of the trust govern
Federal Financial Aid
Counted as asset of parent if owner is parent or dependent student
Counted as the student’s asset
Counted as the student’s asset and can be counted as the student’s income4
Investments
Menu of investment strategies as developed by the program
Investments available at the custodian (e.g., Schwab or Fidelity)
Investments available at the custodian (e.g., Schwab or Fidelity)
Capital Gains Treatment
All investment gains in the account avoid capital gains tax when used for qualifying expenses
All investment gains subject to capital gains tax
All investment gains subject to capital gains tax
Use for Nonqualifying Expenses?
Withdrawn earnings subject to federal tax and 10% penalty
Funds must be used for benefit of the minor
Terms of the trust govern
Family #1: Jane and Harry have a $7,000,000 portfolio and a newborn son.
529 Plan
Jane and Harry can contribute $30,000 per year to their son’s 529 plan without using any of their lifetime gift exclusion. These assets will grow and hopefully cover all of their son’s college education. As the table above indicates, 100% of the growth in the 529 plan can be withdrawn tax-free when used for qualifying expenses. If a significant excess of funds remains in the 529 plan after their son graduates, the funds can be used to pay for graduate school. Jane and Harry can also change the beneficiary to a qualifying family member.
UTMA/UGMA
If overfunding the 529 plan is a concern and there aren’t any viable options for a beneficiary change later on, Jane and Harry could gift $30,000 per year into an UTMA/UGMA account up until their son reaches a certain age (let’s say seven years old). They will have contributed $210,000 into the plan by then, plus earned growth from investments, and still have another 11 years to let the 529 plan grow. Unlike 529 plans, the funds in the UTMA/UGMA account can be used for some of life’s other big-ticket items, such as a down payment on a house or a wedding. When Jane and Harry’s son reaches age 18 or 21 (depending on which state they live in), he assumes control over the UTMA/UGMA account.
Irrevocable Trust
If Jane and Harry aren’t comfortable with the idea of their son controlling a potentially large sum of money at age 18 or 21, they can opt instead to create an irrevocable trust. Like an UTMA/UGMA account, if the trust includes a Crummey power, they can use their annual exclusions and contribute up to $30,000 per year to the trust. Unlike an UTMA/UGMA account, however, an irrevocable trust allows Jane and Harry to set guardrails on the funds, including choosing the age at which their son gains control of the funds. They may also decide to give their son portions of the trust’s principal over time.
Family #2: Tim and Diane have a $30,000,000 portfolio and newborn twins.
Irrevocable Trusts
With a much larger investment portfolio and the potential for owing estate tax at their deaths, Tim and Diane will likely approach their savings plan a little differently than Jane and Harry and forgo the 529 plan or UTMA/UGMA options. The current gift and estate tax exemption is $11,700,000 per person, meaning Tim and Diane’s combined gift and estate tax exemption is $23,400,000. This exemption applies to both gifts and estate taxes, so whatever exemption is used for gifting (beyond the current combined annual gift tax exclusion of $30,000) will reduce the amount that can be used at their deaths to decrease their taxable estate. With that said, Tim and Diane could look to reduce the value of their taxable estate by gifting to the twins. One technique they should consider is paying for the twins’ college tuition directly. This reduces their taxable estate but doesn’t use up their annual gift tax exclusion or their lifetime gift and estate tax exemption. Since they would be paying for tuition directly to the schools, they can also open two irrevocable trusts to take advantage of their annual exclusion. These trusts would be used to build a nest egg for the twins that can be used for a variety of expenses after they reach the age limit defined in the terms of the trust.
It’s worth noting that there is a different type of irrevocable trust that Tim and Diane can take advantage of. The irrevocable trusts discussed in this article (Crummey trusts) are mainly funded using the annual gift exclusion. There are other types of irrevocable trusts that utilize larger lifetime gifts, not the annual gift exclusion, to remove large amounts of wealth from one’s estate. Tim and Diane should consult their financial advisor and estate attorney to decide if they should make gifts in excess of the annual exclusion amounts to irrevocable trusts.
In Summary
When parents begin planning for their children’s futures, it’s important to know there are multiple avenues to do so. 529 plans are great when saving specifically for college, as assets grow tax-free. UTMA/UGMA accounts and irrevocable trusts work well to build general wealth for your child as there are little to no restrictions on how the funds can be spent. If giving your child too much money too early in life is a concern, irrevocable trusts give you the power to choose when your child can access the principal. If you want to learn more about these savings methods and determine if they’re appropriate for your situation, please contact a member of your Cerity Partners wealth management team.
2 “The Crummey power, named after a taxpayer from the landmark tax case in 1968, is an often used trust provision that allows a gift that would otherwise be a future interest gift to be treated as a present interest gift, and thus be eligible for the annual gift tax exclusion. Crummey powers give the beneficiary a limited time (often 30, 45, or 60 days) to withdraw contributions to a trust at will, converting the future interest gift to a present interest gift. This withdrawal right is generally limited to an amount equal to the current annual gift tax exclusion. If the beneficiary does not exercise this right within the specified time, the Crummey power is deemed to have lapsed and the assets remain in trust.” Stimmel Law, “Crummey Powers for Avoiding Gifts Tax,” https://www.stimmel-law.com/en/articles/crummey-powers-avoiding-gifts-tax#:~:text=The%20Crummey%20power%2C%20named%20after,the%20annual%20gift%20tax%20exclusion
3 If an individual utilizes the 5-year election period, contributing $75,000 in one lump sum to a 529 plan, but dies three years later, $30,000 of the $75,000 will be included in their gross estate.
4 Trust funds must be reported as the beneficiary’s asset on Free Application for Federal Student Aid (FAFSA), even if access to the trust is restricted. Any payments received from the trust during the base year (prior-prior year) must be reported as income on the FAFSA. Saving for College, “How Do Trust Funds Affect Financial Aid for College,” https://www.savingforcollege.com/article/how-do-trust-funds-affect-financial-aid-for-college
Sean is a Principal based in the San Francisco office. He provides comprehensive financial planning and investment management services to private and institutional clients. Taking a deep and proactive role in the management of his client’s wealth, Sean incorporates financial planning across all aspects of a client’s life or business.
Prior to joining Cerity Partners, Sean was a Wealth Manager at B|O|S working closely with clients to create advisory plans that covered a variety of services from a team of professionals including tax and legal advisors. Sean initially joined B|O|S as a member of the Client Associate Team where he handled day-to-day client administrative and operational needs.
Sean earned his Bachelor of Science in Business Administration and Financial Management from California Polytechnic State University in San Luis Obispo. He holds the Certified Financial Planner (CFP®) designation and was the recipient of the 2016 “Outstanding Student Award” from the University of California, Berkeley Extension Certificate Program in Personal Financial Planning.
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