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Question:
My wife and I have two sons, 17 and 15. We are both firm believers in the value of higher education.
We saved for our sons’ college educations by contributing between $2,000 and $7,000 every year to separate investment accounts since they were born (not in a 529 plan). The older son will start college this fall and has been awarded scholarships that effectively give him a full ride, including room and board. The younger son will start college in two years and will likely get scholarships to reduce his college expenses to between $15,000 and $20,000 per year, including room and board.
We conservatively estimate there will be a surplus of $180,000 in their combined college funds after paying for their bachelor’s degrees. We would like to use the surplus to pay for their post-graduate degrees, if they choose. Otherwise, we’d like to use the money to make a positive impact on their financial futures, such as a down payment on a house, or a college fund for their own children.
We also want to prevent any feelings of animosity between them later in life because we gave more money to one than the other.
Our thinking all along has been to keep the money for each son separate. Each account will have about the same value when the son enters college. We’d use the money in the account to pay for his bachelor’s degree and graduate degree, and if there’s any remainder, use it to help him at a later time. However, we’re now questioning if that method of dividing up the money is actually the most fair and the best use of the funds.
Our older son didn’t really work harder to earn his scholarships. He’s just incredibly smart (for lack of a better word) and school is much easier for him. Our younger son is still a straight-A-student and will do well in college. He works harder to earn his grades, but he’s not going to reach the same level of purely academic prowess in high school, and it’s unlikely he’ll receive as much scholarship money, but we’d like to see him reach the same level of education without having to work even harder to pay for it. Additionally, there may not be enough money to send both sons to graduate school. However, if one son decides to go to graduate school and the other does not, the extra money could still be used for education, as it was originally intended. Of course, there’s the potential for delaying graduate school a few years, too.
We also want to prevent any feelings of animosity between them later in life because we gave more money to one than the other.
Lastly, if there actually are funds remaining after paying for college, we’re looking for suggestions on how to use it to improve our children’s financial future. Note that we don’t need it for ourselves. We aren’t what we consider wealthy, but our retirement planning is on track, we have a six-month emergency fund, our house will be paid off in four months, and we have no other debt.
Answer No. 1: Financial Fairness
Questions of fairness present many parents with a conundrum. Do you save equally for each child’s college education, or do you save more for one child than the other?
Should you save equally for both children, since you love both children the same?
Or, should you save more for the younger child, since college will cost more by the time they enroll, due to tuition inflation?
Luckily, the rule of thumb to save $250 a month from birth for an in-state four-year public college and $550 for a four-year private college usually does not change over a few years difference in age, because the amounts are rounded to the nearest multiple of $50. Otherwise, the amount would need to be adjusted annually according to college tuition inflation. So, you could choose to contribute the same amount for each child.
Yet, even if you try to save equally for both children, the cumulative savings will likely differ because you started saving for each child at different times. Interest rates, fees and the resources you can afford to contribute will change over time. If you start saving for both children at the same time, as opposed to starting for each child at birth, the younger child will accumulate more savings because of a longer time horizon. There will also be differences in risk tolerance due to differences in the time horizon.
That doesn’t seem fair, unless you set the same savings goal for each child.
If you save in parent-owned 529 plan accounts, as opposed to custodial bank or brokerage accounts, you can rebalance the funds between the children by transferring money from one 529 plan account to the other.
But, there will also be differences because each child is unique.
What if one child doesn’t go to college? Or wins a full scholarship? Or their college costs are covered because they enroll at a U.S. Military Academy? What if one child enrolls at a high-cost private college and the other at a low-cost public college? What if one child goes on to graduate school and the other doesn’t? What if one child majors in a more lucrative field of study and the other pursues a lower-paying career? What if one child suffers from an illness or disability and needs more help?
Some families may run out of money for the younger child because they didn’t save enough for the older child, placing the younger child at a disadvantage.
No matter what you do, feelings may be hurt. If you give the same amount of money to both children, the younger child will be forced to borrow more, burdening them with more student loans. If you give more money to the child with the greater costs or needs, the other child might resent that.
It may help to distinguish between paying for college and other purposes. If there’s leftover money after you’ve fulfilled your promise to help them pay for college, perhaps you can split it evenly among the children. Your commitment was to pay for college, perhaps even a particular type of college, and not to provide a specified sum toward college costs.
Splitting the leftover money evenly lets each child choose how to use their share of the money. They could use it to buy a car, pay for a wedding, save it for a down payment on a home, start a business, get a head start on retirement savings, build a college fund for their own children or repay their student loans.
Communication with the children can help avoid acrimony. Be honest and transparent about how you decided how much to contribute to each child’s college education. Be clear that differences in the savings account balances are not a reward for good behavior or a measure of your love for each child. Rather, you are addressing your children’s needs, and each child’s situation is different.
Answer No. 2: Titling of Account
It is important to understand the titling of the investment accounts, since that can affect the possible uses of the money. The main options are a Totten trust account and a custodial account.
A Totten trust or payable on death account, which is titled “parent in trust for child”, passes to the child outside of probate upon the death of the child. The parent can use the money for any purpose and has no duty to use it for the benefit of the child.
A custodial account, which is titled “parent as custodian for child”, is established under the Uniform Transfer to Minors Act (UTMA) or Uniform Gift to Minors Act (UGMA). The money is legally the property of the child and must be used for the benefit of the child.
Thus, if the college savings funds are in a custodial brokerage account, the money cannot be given to a sibling.
This is in contrast with a 529 college savings plan where a parent is the account owner and the child is the beneficiary. The account owner can change the beneficiary to a member of the family of the current beneficiary, such as a sibling.
(There is also a different type of 529 plan, called a custodial 529 plan, where the child is both account owner and beneficiary. If the child has not yet reached the age of majority, the custodial 529 plan account is managed by a custodian. However, the custodian cannot change the beneficiary on the custodial 529 plan account.)
The money could also be in a brokerage account in the parent’s name, in which case the parent can use the funds to pay for either child’s college education, or for any other purpose.
The titling of the account can also affect the child’s eligibility for need-based financial aid. If the money is in a custodial bank or brokerage account, it is reported as a student asset on the Free Application for Federal Student Aid (FAFSA). If the money is in a custodial 529 plan account, or in the parent’s bank or brokerage account, it is reported as a parent asset on the FAFSA.
Student assets are assessed more heavily on the FAFSA than parent assets. The student’s eligibility for need-based financial aid is reduced by 20% of the student assets. Parent assets, on the other hand, are assessed on a bracketed scale with a top bracket of 5.64% after subtracting a small asset protection allowance based on the age of the older parent. Thus, $10,000 in a child’s custodial brokerage account will reduce aid eligibility for $2,000 and $10,000 in the parent’s name will reduce aid eligibility by at most $564.
Mark Kantrowitz is Publisher and VP of Research for Savingforcollege.com, the most popular guide to saving and paying for college.
