Hugh F. Doherty, DDS, CFP
Most doctors are concerned that they will not be able to save enough for their children`s education. College costs continue to rise on an annual basis. With financial aid beyond the reach of most doctors, getting started early and using tax-deductible strategies are the keys to efficiently funding your children`s future college costs.
The higher-tax-bracket doctors can reduce these costs through shifting income to their lower-bracket children, by employing the children in their practice. Under current tax law, each child can earn $4,400 in 2000. You pay no federal and, in most cases, no state income taxes. You can deduct their wages as an unreimbursed employee business expense on Schedule A. Since the value of the standard deduction and personal exemption are indexed for inflation each year, the tax-free earnings amount will increase each year.
How to invest earned funds
A recommended vehicle is a UTMA (Uniform Transfer to Minors Act - formerly UGMA for Uniform Gifts to Minors Act) custodial account. With growth serving as the main investment objective, the account could blossom into a large amount. Once you place the funds in an UTMA, you relinquish control. The child owns the monies.
Now, suddenly, the doctor awakens one morning and realizes that he or she has been so successful with the funding strategies that the appreciated value of the monies will result in a 21-year-old having unfettered access to significant assets. Having broken the shell, doctors ask, "How can we put the egg back in? Can I regain control?" Be careful; you could make some serious mistakes.
Some UTMA custodians simply take the money. The mutual fund, brokerage firm, bank, etc., simply processes the transaction. What`s wrong with that? If you do, the IRS will want to examine income tax consequences for the years that the funds were in the UTMA account. Also, once the child reaches the age of majority (at 18 or 21, depending upon the jurisdiction), he or she could bring suit against the custodian of the account.
The custodian spends money from the UTMA funds for the child`s benefit before college; e.g., pays bills directly for dance classes, horseback riding, karate lessons, sports programs, summer camp, music lessons, etc. This defeats the purpose of the future growth of these assets for college, but minimizes or eliminates the child`s "access to excess" at age 21.
Stategies to gain control
When the child attains the age of majority, have him or her legally assign the interests in the UTMA to a trust that the child can create, which designates the parents as trustees until some later point in life.
(1) Establish a family limited partnership (FLP) or limited liability company (LLC). The UTMA custodian contributes the assets in kind (to avoid any capital gains or other income tax consequences) to the FLP or LLC and takes back an equity interest. The UTMA remains intact. However, what it now holds is a limited partnership or member interest. The parents are the general partners and the child has the inability to access the underlying funds.
(2) Establishing an I.R.C. Section 2503© trust is another option to opening an UTMA, because control can go beyond age 21. The downside is the cost of setting up the trust. The doctor needs to trade off desire for control versus legal fees.
(3) Use the ILIT (Irrevocable Life Insurance Trust). The trust can typically hold assets other than or in addition to insurance policies for the benefits of all children. Therefore, the FLP, LLC, 2503© trust, and ILIT should be studied before clients fund UTMAs initially - that is, before they "scramble the egg."
Hugh F. Doherty, DDS, CFP, is a Certified Financial Planner, national lecturer, financial advisor to the health-care profession, and CEO of Doctor`s Financial Network. For further information on lectures, study club workshops, or consultations, you can fax to (732) 449-3229, send e-mail to Drfinne[email protected], call (800) 544-9653, or visit www.dr.hughdoherty.com.