By Wade Moller
Do your children dream of attending Harvard, Stanford or Yale? If your answer is no, then you need to keep reading.
Everyone understands that a four-year degree from a prestigious institution will set them back a small fortune. Obviously, $40,000 or more a year is nothing to scoff at, but the scarier proposition is that, according to figures released by the non-profit College Board, tuition increases at public universities actually outpaced those at private colleges and universities for the better part of the last decade.1
Qualified Tuition Programs
There is no one perfect solution to avoiding the financial drain associated with paying for your children's higher education; however, the federal government has provided one tool that all parents should seriously consider using - Qualified Tuition Programs ("QTPs"). QTPs are established and maintained by states (or state agencies) and eligible educational institutions2 to assist in paying higher-education expenses.
QTP contributions must be in cash. In addition, contributors are prohibited from directly or indirectly managing their QTP investments or any earnings. However, at the time the account is established, you can select from different investment strategies designed exclusively for the program and to modify the investment strategy once a year.
QTPs come in two main varieties: prepaid tuition programs3 and 529 college savings plans. Prepaid tuition programs allow persons to prepay and guarantee college education costs through lump sum or periodic payments. In return for these early payments, these programs generally allow a purchaser to lock in current tuition rates. In contrast, 529 plans are set up for the sole purpose of meeting qualified higher-education expenses of the designated beneficiary.
The choice of a prepaid tuition program over a 529 plan depends in large part on the willingness to accept investment risk. Because the earnings of a prepaid tuition program are tied directly to the increases in tuition, the return is certain to be sufficient to cover the costs of attending an in-state institution or a participating educational institution in the future. The return may be insufficient, however, to keep up with tuition increases at out-of-state institutions or institutions not participating in the plan. A prepaid tuition program also could, without proper planning, have adverse consequences on the designated beneficiary's ability to receive federal financial aid.
QTP Benefits
Much as with a Roth IRA, earnings during the existence of a QTP are not subject to income tax nor are later distributions made to the account beneficiary so long as they are used to pay "qualified higher-education expenses."4 If the beneficiary decides not to attend college, the account holder may designate a new beneficiary without adverse income tax consequences, so long as the new beneficiary is a "member of the family" of the former beneficiary.5 However, a change in designated beneficiary will be subject to gift tax if the new beneficiary is in a lower generation than the former beneficiary.6
In addition, QTP contributions are treated as a completed gift of a present interest in property, even though the contributor retains some control over the contributions and the funds will not be used for many years to come. As such, QTP contributions are eligible for the annual gift tax exclusion and generation-skipping transfer tax exclusion, which is $12,000 for 2006. This allows contributors to set aside money for their children's future now, free of gift tax or generation-skipping transfer tax,7 and watch the funds grow tax-free until needed to pay for college.8
Creditor Protection
QTP contributions where a child is the designated beneficiary generally are fully excludable from a bankruptcy estate if contributed more than two years before the bankruptcy petition is filed. If the contributions were made between one year and two years prior to filing, the exclusion is capped at $5,000 per beneficiary. Washington also provides statutory protection from creditors for units purchased in its prepaid tuition program more than two years prior to filing a bankruptcy petition or the date of judgment.9 n
Wade Moller is an associate in the business department of Ogden Murphy Wallace, P.L.L.C. Moller received his LL.M. in taxation from the University of Florida, Levin College of Law, in 2002. He can be reached at wmoller@omwlaw.com. The information in this article is not intended as legal advice, nor should it be relied upon as such. Because the individual circumstances of each taxpayer vary greatly, your personal tax advisor should be consulted before electing to take any of the actions outlined above.
