B.14 Education savings vehicles

Question 1

Which of the following educational savings vehicles allows for tax-free withdrawals for qualified education expenses?

A. Traditional IRA
B. 529 plan
C. Roth IRA
D. Coverdell Education Savings Account

Answer 1

B. 529 plan

The earnings on contributions to a 529 plan grow tax-free, and withdrawals for qualified education expenses are also tax-free.

B.14 Education savings vehicles

Question 2

Which of the following is not a qualified education expense for 529 plan withdrawals?

A. Tuition and fees
B. Room and board
C. Textbooks
D. Health insurance

Answer 2

D. Health insurance

Although health insurance is an important expense for students, it is not considered a qualified education expense for 529 plan withdrawals.

B.14 Education savings vehicles

Question 3

Which of the following types of 529 plans allows for investments in mutual funds and other securities?

A. Prepaid tuition plan
B. Savings plan
C. Investment plan
D. Coverdell ESA

Answer 3

B. Savings plan

The savings plan is the most common type of 529 plan, and it allows for investments in mutual funds and other securities.

B.14 Education savings vehicles

Question 4

Which of the following is not a benefit of a Coverdell Education Savings Account?

A. Tax-free withdrawals for qualified education expenses
B. Ability to invest in a wide range of investments
C. Ability to use funds for K-12 education expenses
D. No contribution limit

Answer 4

D. No contribution limit

Unlike some other types of retirement and education savings accounts, Coverdell ESAs have a relatively low contribution limit of $2,000 per year.

B.14 Education savings vehicles

Question 5

Which of the following is a benefit of a traditional IRA for education savings?

A. Tax-free withdrawals for qualified education expenses
B. Penalty-free withdrawals for qualified education expenses
C. Higher contribution limits than other education savings accounts
D. Contributions are tax-deductible

Answer 5

B. Penalty-free withdrawals for qualified education expenses

Although withdrawals from a traditional IRA are generally subject to income tax and a 10% penalty if taken before age 59 ½, the penalty is waived for withdrawals for qualified education expenses.

B.14 Education savings vehicles

Question 6

A grandparent wants to contribute to their grandchild’s education savings account. Which of the following options would allow the grandparent to contribute the most money without incurring gift tax?

A. Contributing to a 529 plan owned by the grandparent
B. Contributing to a 529 plan owned by the grandchild’s parents
C. Contributing to a Coverdell ESA owned by the grandparent
D. Contributing to a traditional IRA owned by the grandchild

Answer 6

B. Contributing to a 529 plan owned by the grandchild’s parents

Under current tax laws, individuals can contribute up to a specific yearly amount to a 529 plan without incurring gift tax, and there is an option to make a one-time contribution based on a multiple of that yearly amount and spread it over five years. Contributions to a 529 plan owned by a grandparent count as a gift and may impact the grandchild’s eligibility for financial aid.

B.14 Education savings vehicles

Question 7

Sarah and John want to set aside a substantial amount for the higher education of their twin daughters, especially since they have over 15 years for the investments to appreciate. They have recently received an inheritance of $500,000 and are keen on using this amount for their children’s future. Given that their adjusted gross income (AGI) is $120,000, which of the following would best suit Sarah and John’s objectives?

A. Coverdell Education Savings Account
B. Section 529 Qualified Tuition Plan
C. Laddered Treasury Portfolio
D. Uniform Transfers to Minors Act (UTMA) account

Answer 7

B. Section 529 Qualified Tuition Plan

Both the Coverdell Education Savings Account (A) and the Section 529 Qualified Tuition Plan (B) are designed specifically for educational savings. However, the Coverdell ESA has an annual contribution limit and may have income restrictions. In contrast, the Section 529 plan typically allows for much larger contributions without the restrictive income limitations of the Coverdell. Given the size of the inheritance and the AGI mentioned, the 529 plan would be the most effective choice for Sarah and John. The Laddered Treasury Portfolio (C) and UTMA account (D) can also be used for saving for education, but they do not offer the same tax advantages for education savings as the 529 plan.

B.14 Education savings vehicles

Question 8

Marilyn is planning to save for her daughter’s college education. She has considered various savings options and is intrigued by the benefits of a Roth IRA. However, she is also aware that every financial decision has potential drawbacks. Which of the following would be a potential downside for Marilyn if she chooses to use a Roth IRA to save for her daughter’s education expenses?

A. Earnings on Marilyn’s contributions may be taxed at her current income tax rate.
B. Marilyn’s contributions to the Roth IRA will not reduce her taxable income in the year they are made.
C. If Marilyn makes withdrawals for non-qualified education expenses, they may be subject to a 10% penalty.
D. The annual contribution limits for the Roth IRA are lower than those for some other education-specific savings accounts.

Answer 8

B. Marilyn’s contributions to the Roth IRA will not reduce her taxable income in the year they are made.

One of the potential downsides of using a Roth IRA for education savings is that contributions are made with after-tax dollars and are not tax-deductible. This means Marilyn will not receive an immediate tax benefit for the contributions she makes into the Roth IRA. In contrast, some other education savings accounts may offer tax-deductible contributions or other tax advantages. While withdrawals of contributions from a Roth IRA for education expenses are not subject to taxes or penalties, the lack of an upfront tax deduction could be a significant disadvantage for some taxpayers.

B.14 Education savings vehicles

Question 9

Which of the following is not a requirement for a qualified distribution from a 529 plan?

A. The beneficiary must use the funds for qualified education expenses
B. The account owner must be a U.S. citizen or resident alien
C. The withdrawal can be used for K-12 tuition
D. The withdrawal must be made before the beneficiary turns 30

Answer 9

D. The withdrawal must be made before the beneficiary turns 30

There is no age limit for making qualified withdrawals from a 529 plan, as long as the funds are used for qualified education expenses.

B.14 Education savings vehicles

Question 10

Which of the following is a potential advantage of using a Coverdell ESA for education savings?

A. Contributions are tax-deductible
B. Withdrawals for K-12 education expenses are tax-free
C. There is no limit on annual contributions
D. There are no income restrictions on contributions

Answer 10

B. Withdrawals for K-12 education expenses are tax-free.

While Coverdell ESAs have a relatively low contribution limit of $2,000 per year, they offer the ability to withdraw funds tax-free for qualified K-12 education expenses in addition to qualified higher education expenses.

B.14 Education savings vehicles

Question 11

Which of the following is a potential disadvantage of using a Coverdell ESA for education savings?

A. Funds must be used for higher education expenses only
B. Contributions are not tax-deductible
C. Withdrawals for non-qualified expenses are subject to income tax and a penalty
D. There is a low annual contribution limit

Answer 11

D. There is a low annual contribution limit

Coverdell ESAs have a relatively low contribution limit of $2,000 per year, which may not be sufficient to fully fund a beneficiary’s education expenses.

B.14 Education savings vehicles

Question 12

Sarah Nguyen is a financial planner who is advising the Lee family on the best way to save for their son’s college education. The Lees want to ensure that the money they save is used for their son’s educational expenses, but they also want some flexibility in case their son receives a scholarship or decides not to attend college. Sarah is considering recommending a custodial account for education savings.

Which of the following is a potential advantage of Sarah recommending a custodial account to the Lee family?

A. The account can be used to pay for expenses unrelated to education should the son not require the funds for college.
B. Should the original beneficiary not need the funds, the account can be transferred to another family member for their educational needs.
C. Contributions to the custodial account will reduce the Lee family’s taxable income.
D. Any earnings on the contributions to the account will not be subject to federal income tax.

Answer 12

B. Should the original beneficiary not need the funds, the account can be transferred to another family member for their educational needs.

Custodial accounts under the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA) allow the donor to name a custodian to manage the account for the benefit of a minor. One of the advantages of a custodial account is its flexibility, including the ability to change the beneficiary to another family member if the original beneficiary does not need the funds for education (subject to any applicable gift tax considerations). Contributions to a custodial account are not tax-deductible, and the earnings are not tax-free; they are taxed at the child’s rate if above a certain threshold. The account can indeed be used to pay for non-education related expenses, but this is not seen as an advantage in the context of saving specifically for education.

B.14 Education savings vehicles

Question 13

Sarah wants to open an education savings account for her 5-year-old son, but she is unsure which option is best for her family. Her son is likely to attend college in their home state and they want to maintain control over investment choices. Which of the following education savings accounts is likely the best fit for Sarah’s needs?

A. 529 plan
B. Roth IRA
C. Coverdell ESA
D. Custodial account

Answer 13

A. 529 plan

Since Sarah’s son is likely to attend college in their home state, a 529 plan may offer additional state tax benefits. Additionally, 529 plans allow account owners to maintain control over investment choices while still benefiting from tax-advantaged growth.

B.14 Education savings vehicles

Question 14

Tom and Jane are considering using a Roth IRA for their daughter’s education savings. Their daughter is likely to attend college out of state and they are concerned about potential taxes and penalties if they need to withdraw funds for non-qualified expenses. Which of the following is a potential downside of using a Roth IRA for education savings?

A. Contributions are not tax-deductible
B. Withdrawals are not subject to a penalty if used for qualified education expenses
C. Earnings on contributions are subject to income tax if withdrawn before age 59 ½
D. Contribution limits are lower than other education savings accounts

Answer 14

C. Earnings on contributions are subject to income tax if withdrawn before age 59 ½

While contributions to a Roth IRA are not tax-deductible, they can be withdrawn at any time without taxes or penalties because they were already taxed. However, earnings on contributions are subject to income tax if withdrawn before age 59 ½, and may also be subject to a 10% penalty if used for non-qualified expenses. This means that if Tom and Jane need to withdraw earnings from the Roth IRA to pay for their daughter’s college expenses before she turns 59 ½, they may face income taxes on those earnings, which could reduce the amount available for education expenses.

B.14 Education savings vehicles

Question 15

John, age 40, and Maria, age 35, have a combined annual income of $105,000. They recently became parents. Both John and Maria graduated from an expensive private college and wish for their child to attend the same institution. They plan to save $2,000 per year for this future college education expense. They aim to choose an investment strategy that will maximize tax efficiency and optimize their child’s chances of qualifying for financial aid. Which of the following strategies would BEST meet their objectives?

A. Invest in their child’s name using a Uniform Transfer to Minors Act (UTMA) account
B. Invest in a Coverdell Education Savings Account for their child
C. Make contributions to John’s Roth IRA
D. Make contributions to Maria’s Roth IRA

Answer 15

B. Invest in a Coverdell Education Savings Account for their child

A Coverdell Education Savings Account (ESA) offers tax-free growth and withdrawals for qualified education expenses, making it tax-efficient. Unlike assets in a UTMA account, which are considered the student’s assets and could reduce eligibility for financial aid, assets in a Coverdell ESA are considered assets of the parent. This can be more favorable for financial aid calculations. Contributions to John or Maria’s Roth IRA would indeed be tax-efficient, but withdrawals for non-qualified expenses could result in penalties. Additionally, IRA balances aren’t initially counted as assets on the Free Application for Federal Student Aid (FAFSA), but once funds are withdrawn, they can count as student income, potentially affecting aid eligibility.

B.14 Education savings vehicles

Question 16

Jane and Robert, a married couple, are considering funding their child’s future education. They are contemplating a one-time contribution of $155,000 to a Section 529 plan. Which of the following best describes the potential tax consequences of their contribution?

A. The couple will be subject to a gift tax for the full $155,000 contribution.
B. The couple will be able to apply the 5-year gift-tax averaging provision, treating the contribution as $31,000 per year for 5 years for gift-tax purposes.
C. The contribution will be entirely tax-free with no gift tax implications.
D. The couple can only contribute up to the annual gift-tax exclusion amount, and any excess will be subject to a gift tax.

Answer 16

B. The couple will be able to apply the 5-year gift-tax averaging provision, treating the contribution as $31,000 per year for 5 years for gift-tax purposes.

Section 529 plans allow for a special provision where larger contributions can be treated as if they were spread out over a 5-year period for gift tax purposes. Given the annual gift-tax exclusion amount (as of the last update in 2022) is $15,000 per person, a married couple can contribute up to $30,000 per year without incurring gift tax. By leveraging the 5-year gift-tax averaging provision, they can contribute up to $150,000 ($30,000 x 5 years) without gift tax consequences. If Jane and Robert contribute $155,000, only $5,000 would potentially be subject to gift tax considerations, but the majority of the contribution could be spread out over the 5 years to avoid immediate gift tax implications.

B.14 Education savings vehicles

Question 17

Which of the following statements is true regarding 529 College Savings Plans?

A. Contributions are federally tax-deductible.
B. Withdrawals for qualified education expenses are free from federal tax.
C. Funds can only be used for tuition expenses at private universities.
D. There is a penalty for withdrawals made after the beneficiary reaches age 30.

Answer 17

B. Withdrawals for qualified education expenses are free from federal tax.

Contributions to 529 plans are not federally tax-deductible, although they may be deductible on state tax returns depending on the state. The funds can be used for a variety of qualified education expenses, not just tuition or not just at private universities. There is no age-related penalty for withdrawals; however, there are penalties and taxes on earnings if the money is used for non-qualified expenses.

B.14 Education savings vehicles

Question 18

A client wants to open an education savings account for their grandchild and is considering a Coverdell ESA. Which of the following is a limitation of the Coverdell Education Savings Account (ESA)?

A. Contributions can be made regardless of the contributor’s income level.
B. The account can be used to fund elementary and secondary education expenses.
C. Contributions are tax-deductible at the federal level.
D. There is an annual contribution limit of $2,000 per beneficiary.

Answer 18

D. There is an annual contribution limit of $2,000 per beneficiary.

Coverdell ESAs allow for contributions up to $2,000 per year per beneficiary and are not deductible for federal tax purposes. Contributions to Coverdell ESAs are also subject to income phase-outs, meaning higher-income individuals may be limited or unable to contribute. These accounts can indeed be used to fund elementary, secondary, and post-secondary education expenses.

B.14 Education savings vehicles

Question 19

A client asks about the tax implications of using a 529 plan for their child’s off-campus housing expenses while attending college. Which of the following is correct?

A. Housing expenses are never considered a qualified expense for 529 plans.
B. Housing expenses can qualify, provided they do not exceed the room and board allowance determined by the college for federal financial aid purposes.
C. Off-campus housing costs are only considered qualified expenses if the student is attending a foreign university.
D. Only on-campus housing expenses are covered under 529 plan distributions.

Answer 19

B. Housing expenses can qualify, provided they do not exceed the room and board allowance determined by the college for federal financial aid purposes.

For 529 plans, qualified higher education expenses include room and board, provided that the student is enrolled at least half-time. The expenses for off-campus housing must not exceed the allowance for room and board included in the cost of attendance as determined by the college for federal financial aid purposes.

B.14 Education savings vehicles