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Understanding Section 529
Investment Plans
For College Funding & Estate Planning Purposes
by Paul M. League,
CFP
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Saving for college requires
careful planning and a high level of commitment. In fact, next to retirement, saving
for college may be the single largest expense that a family will bear. Predictions
are that tuition costs for a private 4-year college will exceed $250,000 by the year
2010.
There are a number of ways of funding for these higher education costs one of which
is through an EDUCATION IRA; however, it, even under the Tax Relief And Reconciliation
Act of 2001 (H.R. 1836), as shown below, remains far to limited to effectively meet
these ever increasing costs:
- Education IRA limits
are increased from the current $500 to $2,000 beginning in 2002 and the phase-out
range increases for joint filers to double that of single filers ($190,000 - $220,000).
- Education IRA proceeds
may be used to pay for elementary and secondary school tuition and expenses, in addition
to paying the costs of higher education.
- Beginning in 2002,
the $2,500 limit on student loan interest deductions is repealed and the phase-out
thresholds are increased.
IRS Section 529 Plans,
perhaps the best funding vehicle, offer parents and grandparents, as well as other
interested parties, various important tax benefits while serving as an especially
preferred vehicle for meeting college funding needs.
529 Plans came about through Federal legislation in 1996, and are implemented on
a voluntary basis by individual States (about 48 now offer these Plans). Most of
these plans can be purchased, or funded, not only by residents, but also non-residents.
These Plans have gone through an evolution in design from Pre-Paid Tuition Programs,
to Age Based Savings Plans, to Multiple Investment Option Plans including equity,
fixed income, and money market. Most Plans being funded today are of this latter
type.
There are 3 Parties to a 529 Plan; namely, the Donor; the Participant (equal to the
"owner" who retains control over the Plans assets); and the Beneficiary.
For Estate Planning purposes Section 529 Plans allow a Donor to remove assets from
their taxable estates, grow those assets tax deferred, and not lose control over
those assets. The transferred funds are considered a "completed gift",
for estate tax purposes, and are, therefore, no longer a part of a Donors estate.
When the Donor is also named Participant, that Donor maintains control over the gifted
assets, and can exercise that control in a number of very flexible ways, including
but not limited to changing Beneficiaries across generations. The ability to change
the Beneficiary is a distinct advantage to the Donor/Participant over an UTMA/UGMA
that does not permit such changes, as is continued tax deferral beyond the "age
of majority" limits.
Many ask, "is there an advantage to converting a UTMA/UGMA to a Section 529
Plan" and the answer is yes. The primary advantage is that you will continue
the tax deferral beyond the age of majority limit (until redeemed for eligible expenses,
and then at the tax rate of the Beneficiary); however, there is a price to pay. First,
the taxes will have to be paid upon termination or transfer of the UTMA/UGMA. Second,
no additional funding can be made to the replacing 529 Plan. Third, the Donor/Participant
looses the right to change the Beneficiary.
Donors are permitted to "front load" their gifts to any Plan up to 5 years
equating, under current allowances, to $50,000 or $100,000 in the case of spouses.
Further funding can be accomplished, as needed, by electing to use part or all of
the Unified Credit while living, instead of following one's death; however, when
doing so, one should first carefully weigh this in relation to other estate planning
considerations and techniques either already in place or that may need consideration.
Under the Tax Relief And Reconciliation Act of 2001 (H.R. 1836) the scope of qualified
tuition programs has been favorably expanded to include private institutions of post-secondary
education. Also, distributions are to be treated differently and are excludable from
gross income if made after 12/31/2001 for state-sponsored tuition programs, and after
12/31/2003 for non-state programs.
"ADD BACK RULE": If an individual contributes more than $10,000 to a 529
account for a year, elects the 5 year gift rule and then dies before the end of the
5-year period, the "add back" rule will apply even if an individual has
been designated successor participant for the account.
For example, Sue Donor contributes $50,000 to a 529 account for her grandson Junior
in 2001 and designates her daughter Jan Participant as successor participant. Sue
Donor files a federal gift tax return (Form 709) on which she checks the appropriate
box to indicate that she is electing to treat the $50,000 as made ratably over the
5-year period beginning in 2001 (i.e., she's electing the 5-year gift rule). Sue
dies in 2002. When the executor of her estate computes her federal estate tax, the
portion of her $50,000 contribution allocable to the 3 years in the 5-year period
in which she did not live (i.e., $30,000) will be counted in computing her gross
estate. The fact that Sue Donor had named a successor participant (Jan Participant)
does not eliminate the "add back" (note, on death the successor Trustee
becomes the "Participant/Owner").
A final option to Donor/Participants is to "cash out" the Plan. When cashing
out earnings are subject to the Participants tax rate, plus a 10% IRS penalty; however,
there is no penalty upon cashing out upon death, disability, or receipt of a scholarship
from eligible Title IV institutions (i.e. those who receive financial aid).
Section 529 Plan Highlights:
- reductions in gift
taxes
- reductions in generation
skipping taxes
- reductions in estate
taxes
- deferral of current
income taxes & shift to likely lower tax bracket of Beneficiary
- State tax deductible
(State specific)
- No Age Limits
- Large, Per Beneficiary,
Maximum - $256,000 (Plan specific)
- Ability to Gift 5-Years
In Advance ($10k x 5 = $50,000 - if married x 2 = $100,000)
- Retain Control of
Assets + Access to Assets (in case of the "Participant/Owner" after 24
months)
- Retain Right to Change
Beneficiary
- "Qualified Withdrawals"
Taxed at Beneficiary (usually lower) Tax Rate (i.e. Tuition, Room & Board, Books,
Supplies. Travel expenses are not eligible). Under new law, H.R. 1836, excludable
from gross income if made after 12/31/2001 for state-sponsored tuition programs,
and after 12/31/2003 for non-state programs (see above for specific time frames).
- Negative effect to
Financial Aide Programs is lessened. A smaller percentage of a beneficiaries assets
are considered for aide: 5.6%, where the 529 owner is the parent (i.e. the assets
of the 529 Plan are considered to be a "parental asset"), and the student
beneficiary the non-asset holder/owner. With UGMA/UTMA, or other types of assets,
where the child is the legal asset owner, then the negative effect to financial aide
is that 35% of all of these types of "owned" assets are considered, thereby
impeding qualification and/or resulting in a reduction to the allowable or obtainable
amount of financial aide.
- Certain Plans are
suitable for any age group or income level, and offer wide-open options on who are
the named Parties to their Plan.
Also, at the end of the educational years, the assets in a Section 529 Plan can be
used for retirement or, if desired, for the educational needs of additional heirs.
GENERAL DISCLAIMER-INCLUDING RISK: BEFORE INVESTING CAREFULLY REVIEW ANY GIVEN PLANS
OFFERING STATEMENT. MATERIAL DISCUSSED IS MEANT FOR GENERAL ILLUSTRATION AND/OR INFORMATIONAL
PURPOSES ONLY AND IS NOT TO BE CONSTRUED AS INVESTMENT ADVICE. ALTHOUGH THE INFORMATION
HAS BEEN GATHERED FROM SOURCES BELIEVED TO BE RELIABLE, IT CANNOT BE GUARANTEED.
PLEASE NOTE THAT INDIVIDUAL SITUATIONS CAN VARY, THEREFORE, THE INFORMATION SHOULD
BE RELIED UPON ONLY WHEN COORDINATED WITH INDIVIDUAL ADVICE.
Paul M. League, CFPô is the Principal
of League
Financial & Insurance Services, a privately
held company located in Beverly Hills, CA since 1985. League also operates and is
a Registered Representative & Investment Advisor Representative with the Beverly
Hills Branch Office of Royal Alliance Associates, Inc., Member NASD/SIPC-a SunAmerica
Company. League specializes in wealth creation, preservation, and expansion through
both individual and Group benefit programs. Paulís professional affiliations include:
Career Member of NAIFA; AHIA; NAABC; Concerned Planners Group. Paul and his company
provide a wide array of financial planning, insurance, and investment advisory services
for which they are widely known. MAILING ADDRESS: 332 So. Beverly Drive, Suite #101,
P.O. Box 7007, Beverly Hills, CA 90212-7007, Phone 1. 310. 277. 3141, www.LeagueFinancial.com
/ e-mail: Paul@LeagueFinancial.com
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