Back-to-school season has advisors talking tuition strategies

Advisors reveal how they teach parent clients a lesson or two about tax-efficient ways to pay tuition bills.

College students heading to campus over the next few weeks will soon be focusing on their reading assignments, essays and exams. Many of their parents, meanwhile, will be tasked with their own homework after dropping their budding scholars off at school – figuring out the most tax-efficient ways to pay the tuition.

Hopefully, they have financial advisors who can teach them a lesson or two.

“As a financial advisor and father of a 1-year-old, I follow the same advice I give my clients – start saving for college immediately, even if your kids are still in diapers. Setting goals early as part of tax-intelligent planning helps you pursue financial goals like paying for college while striving to keep taxes as low as possible,” said Andrew Barnes, wealth advisor at Wymer Brownlee Wealth Strategies.

Ann Bjerke, head of advanced planning at UBS, advises her ultra-high-net-worth clients to take advantage of the unlimited gift tax exclusion to pay tuition directly to an educational institution. By doing so, she said, parents or grandparents can pay tuition directly and then use their annual gift tax exclusions in other ways.

For a forced savings strategy and to obtain some tax benefits, parents or grandparents can also fund 529 accounts. Donors can make annual exclusion gifts to these accounts, which can grow tax free, and ultimately be used to pay so-called qualified expenses, generally tuition, room and board, and books and supplies.

“This can be a great strategy for grandparents who may not be around to otherwise make direct payments to the educational institution once the child attends,” Bjerke said.

Shawn Stone, director of advisory services at Retirement Planners of America, is also a fan of 529 plans for tax-free growth, especially as a way to put a larger amount in the account upfront.

“I’ve had clients who contribute the absolute max, 5 years of catch-up contributions, in the first few years of a child or grandchild’s life to give many years of tax free growth,” Stone said in an email. “The limit this year is $85K and can be done with each spouse, if they wanted to, so the $85K number is per person donating to the fund.”

Michael Green, wealth management advisor at Apollon Wealth management, notes that in addition to tax-deferred growth on investments in 529 accounts and tax-free distributions for qualified educational expenses, more than 30 states provide a state tax benefit on contributions.

“I encourage savers to first consider their state’s 529 plan and identify if there are any state tax benefits. For those in states that offer no immediate tax benefit, savers could consider leveraging Roth IRAs and life insurance contracts. Both of these vehicles have their own pros and cons and should be evaluated carefully with your advisor,” Green said.

Bjerke says Uniform Gift to Minors Act or Uniform Transfer to Minors Act accounts can also be funded and used to pay for educational expenses. Donors and parents should note, though, that once the child reaches the age of majority, the funds in the account will turn over to the child.

“If an account holds a few hundred thousand dollars, for some children that can be enough of a ‘windfall’ to cause concern,” Bjerke said. “For that reason, we often see clients opting for a trust to hold the annual exclusion gifts, in lieu of an UTMA/UGMA account, which can include some provisions to hold and preserve those funds for the child’s benefit after they reach the age of majority.”

Stone views giving an 18-year-old a large pot of money as a risk unless, of course, the recipient is trustworthy.

“An UTMA is taxed like a post-tax brokerage account with capital gains needing to be paid, but it is at the minor’s tax rate and can provide a huge tax benefit to the donors to the account,” he said.