Paul Ferraresi

High Net Worth (HNW) individuals can not and do not use the typical college savings plans. Many plans have phase outs or limitations. None the less you should be aware of other strategies that the wealthy use and incorporate them yourself.

The classic plans used by everyone:

Here are what HNW people use:

(1) Direct payments by benefactors.
Grandparents and others are often in a position to pay tuition directly, allowing these benefactors to reduce their estate and gift taxes by taking full advantage of the unlimited gift tax exclusion for tuition (and medical) payments. This benefit makes funding 529 plans of limited use (other than paying room and board, which do not qualify for the gift tax annual exclusion) in wealthier families. A practical approach for implementing this plan is for the grandparents (or others) to establish a separate checking account for gifts. The benefactor would then delegate the task of dispensing all annual gifts, tuition and medical payments to a family member or advisor. This person would be responsible for documenting the benefactor’s qualification for the annual gift tax exclusion.

(2) Family limited partnerships (FLPs) and limited liability companies (LLCs).
Most HNW clients are concerned about asset protection, estate taxes and control. Instead of merely funding 529 plans, consider a plan which includes establishing a FLP or LLC to hold family assets. Establish trusts for children, grandchildren and other heirs. Then, have the client make gifts of FLP or LLC interests to the trusts for their heirs, rather than to 529 plans. The children’s trusts can then invest in and remain partners in the family entity, thus helping to achieve broader family goals.

(3) Direct payments to schools.
A wealthy grandparent may prepay tuition directly to schools on behalf of any number of grandchildren enrolled in those schools and the payments, no matter how large in the aggregate, should be exempt from gift and the generation – skipping tax (GST). This approach could enable a wealthy client to save substantial estate taxes and still preserve annual gifts for other planning uses. A 529 plan would limit use of the annual exclusion for tuition, thus limiting overall family tax benefits. Unlike the front- loading of a 529 plan, this is not limited to five years’ worth of gifts, and there is no recapture of tax benefit if the donor dies less than five years after the gift. That is a huge benefit. Further, tuition prepayment doesn’t use up any of the donor’s annual gift exclusion, so the client can still pursue the FLP or LLC plan.

(4) Grantor trusts
A biggie with 529 plans is that the funds grow tax-free. Trusts cannot provide that benefit- well, that’s what some think! As any financial planner knows one can structure investments to minimize current income tax to get close to this result. But there is also a tax technique that can, vis-à-vis the child, make the trust holding college savings “tax-free”: The trust can be structured as a grantor trust so that the donor, not the trust, pays all income taxes. This is done by having the donor expressly reserve certain administrative powers in the trust agreement. The bottom line: Grandma pays all income tax on the trust (well, whatever is left after you’ve invested it in a tax-efficient manner) and the trust grows without diminution from taxes. From a family planning perspective this is equivalent to an additional tax-free gift, above the annual exclusion amount, from Grandma to each grandchild’s trust.