Philadelphia Reflections

The musings of a physician who has served the community for over six decades

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Investing for Children

Many a Mickle Makes a Muckle

There are three major expenses for an average American lifetime. Paying for college, buying a house, and providing for retirement. Unless there is a substantial inheritance, all three of these expenses must be provided for during the four decades from college graduation to retirement. Even in affluent families during prosperous times, that is almost too much burden to carry. Improved longevity leads to longer retirements, depleting family reserves which might have been transferred to grandchildren for their expensive educations. Even families which can afford it, find the legal climate unhelpful. Money given to a grandchild at birth has twenty years to grow, at least tripling before college entrance, but it proves remarkably difficult to take advantage of this opportunity.

It is obviously dangerous to allow children to choose how to spend their own money. They will not merely squander money on trinkets, there are automobiles, illegal drugs, and unwise marriages to consider. A law called the uniform gifts to minors act addresses this issue fairly well, placing assets in the hands of a custodian until the child is nineteen. That's the right idea, but nineteen is too young for many who go on to college, and it would be a blessing if the money in these custodial accounts could be frozen until college bills, if any, have been paid.

Trust Funds

A concept known as the Clifford Trust was created, allowing income from a sum of money to go to minor children (at their lower income tax rates) and then after a minimum of ten years the principal reverts to the donor. That was well intended, but it created a mountain of burdensome paperwork, legal and accounting fees. The Internal Revenue Service probably has very good reason to be suspicious of arrangements for children which primarily cloak tax evasions by their relatives. Nevertheless, the great majority of honest parents trying to pay for college are hounded and hassled in order to prevent a smaller number from cheating. Our lawmakers ought to be able to do better than this.

It was once possible to buy tax-free municipal bonds without coupons --so-called zero coupon bonds, or strips-- which could be put in a safe deposit box and forgotten until college admission time. Unfortunately, the law was changed to require yearly taxes on "virtual" income, and much ado was made of the concealment of personal property from the awareness of the infant owners.

Until Death Do Us Part

Trust funds are expensive to construct and maintain, and taxed at a fixed high tax bracket, often higher than the parents are paying. While college tuition bills are crushing, they are not large enough to make it economical to use ordinary trust funds to sustain them for a few years of concern. As the economy grows steadily more prosperous, more people will face these problems, and sympathy may grow to the point of congressional action. Unfortunately, the families who do not have college problems to finance are an envy obstacle in the eyes of elected officials, and the fairness argument is rehearsed.

Meanwhile, a single share of Berkshire Hathaway stock would pay for college, would probably triple in value from birth to graduation, generating no taxes in the meantime. The problem obviously is to afford that single share when the baby is born, but possibly a sort of mortgage could be devised. There should be more securities like Berkshire Hathaway; long life to its all-too-mortal master, Warren Buffett.

Originally published: Saturday, December 30, 2006; most-recently modified: Wednesday, May 22, 2019