Trusted Advisor: The Expense of Higher Education

Cary Biren, First Republic Investment Consultant, Spectrum

I frequently meet with clients to discuss college planning, and these conversations almost always have one thing in common: a stunned look, followed by, “Wow, I had no idea it might cost that much. …”

Today the cost for four years of higher education at a private university—such as Stanford, Harvard and USC—is approximately $200,000; this includes tuition, room and board, books, and other school-related expenses. For public schools, such as UC Berkeley, the cost is just over $100,000. Regardless of whether it’s for a public or private institution, the numbers are significant, especially when considering that many families support these outlays with after-tax dollars. For new parents, like me, you can’t help but wonder how today’s college expenses will translate 18 years from now, when a child born in 2011 would be entering college.

College calculators—a number of which are available for free on the Internet at websites such as—generally recommend adding 6% a year to today’s estimated current costs. So the family of an infant today can potentially expect that four years at a private university will cost more than $615,000 in 2029 compared to $315,000 for a public university. No matter which—public or private—this is a very expensive proposition—which makes planning and saving for it particularly important.

There are three main ways that one can save for a child’s college education: custodial accounts, 529 plans and traditional investment accounts. There is no silver bullet here; each account comes with numerous pros and cons. Feel free to discuss the matter with your First Republic wealth management professional if you need help deciding which approach, or combination of approaches, might work best for you.

Custodial accounts, sometimes called “Uniform Gift to Minors” (UGMA) accounts, are easy to set up and available everywhere. The account has a beneficiary, the child, and a custodian, generally a parent or grandparent, who is responsible for overseeing the account until the child reaches the age of majority. These accounts are quite flexible, as a custodian who is not the child’s parent has full discretion to use UGMA funds for any expense that benefits the child. If the custodian is the child’s parent and the child is under age 18, the custodian/parent may not use UGMA funds to pay any expense the parent is legally obligated to pay, such as expenses for health, education, welfare and support.

The downside to UGMA accounts is the ownership structure. Since they are titled in the child’s name, UGMAs officially belong to the child and thus would be considered part of his or her assets when qualifying for financial aid. A potentially greater concern is the fact that upon reaching the age of majority (which can be 18 or 21, depending on your state) the child will gain full control of the money. Given adolescents’ propensity for risk-taking, this may cause many families to think twice before setting up this type of savings account for their children’s college education.

Simply put, a 529 savings plan offers a tax-advantaged way to save for higher education. Funds invested in a 529 plan are allowed to grow free from federal dividend and capital gains taxes as long as plan assets are used to fund qualified post-secondary education. The term “qualified” is quite broad: Items such as tuition, room and board, books and various other expenses are all included. Some individual states may even allow for tax-deductible contributions. It’s important to always keep in mind, however, that 529 assets cannot be used to fund anything related to K-12 education—at least not without giving up the tax-free benefit of the plan, in addition to paying a 10% penalty.

529 plans are also flexible in that they can be opened for anyone—your child, grandchild and even yourself—and anyone can contribute to them. As for who controls the assets in the plan, the rules are very clear-cut: The donor, not the beneficiary, is the owner. Thus 529 plans are never within the control of the child. If the listed beneficiary decides not to go to college—or if the donor simply wants to change the beneficiary for any reason—he can do so without penalty as long as the new beneficiary is related to the current beneficiary's immediate family.

Because of the ownership structure of the 529, the content of these plans is not counted as part of the child’s assets when qualifying for financial aid. While parental assets do count, they count to a lesser extent than assets over which the child has direct control.

When it comes to funding either a UGMA or a 529 plan, it’s important to note that all contributions are considered gifts per IRS gift tax rules. In addition, anyone can make a contribution to either plan, up to $13,000 per year, without having to file a gift tax return. With regard to 529 plans specifically, gifting rules are even more generous as they allow donors to contribute up to five years of tax-exempt forward gifting during one year. As always, please consult your tax advisor for detailed advice before making contributions.

The simplest way to save for educational expenses is to open a segregated account in a parent’s name and earmark that account for education. There is no tax benefit to this strategy, but it does preserve full flexibility and control for the parents.

Is there a downside to this approach? Absolutely. Saving in this manner requires discipline; an education-oriented account such as this should not be relied upon when other expenses arise.

So which option is best? That’s going to depend upon your value system and personal situation. The one common thread is that, as with most investment endeavors, an appropriate plan of action—especially one that begins as early as possible—should ultimately pay huge dividends toward reaching your goal.

The views of the authors of these articles do not necessarily represent the views of First Republic Bank.