Education and Health Savings Plans

Question 1

The maximum annual contribution to a Coverdell Education Savings Account is:

A. $2,000
B. $2,500
C. $3,000
D. $4,000

Answer 1

The best answer is A.

The maximum annual contribution to a Coverdell Education Savings Account for a single beneficiary is $2,000.

Question 2

A tax deduction for a contribution to a Coverdell Education Savings Account is:

A. permitted without limitation
B. permitted only for persons earning below a statutory limit
C. not permitted unless the monies remain in the account for at least 5 years
D. not permitted

Answer 2

The best answer is D.

Contributions to Coverdell Education Savings Accounts are not tax deductible - no if’s, and’s, or but’s!

Question 3

High earning individuals are prohibited from making contributions to:

A. Traditional IRAs
B. 401(k)s
C. Coverdell ESAs
D. 403(b)s

Answer 3

The best answer is C.

Any individual with earned income can open a Traditional IRA (whether the contribution will be deductible requires that the individual not be covered by another qualified plans and that person’s income cannot be too high). High earning individuals are prohibited from contributing to Roth IRAs or Coverdell ESAs. There is an income phase-out range, above which contributions are prohibited to either of these For 2019, the top end of the income phase out range for individuals is $110,000 and for couples it is $220,000.

Question 4

Contributions to a Coverdell Education Savings Account must cease when the beneficiary reaches the age of:

A. 16
B. 18
C. 21
D. 30

Answer 4

The best answer is B.

Contributions to a Coverdell Education Savings Account must stop once the beneficiary reaches age 18.

Question 5

A distribution of $15,000 is taken from a Coverdell Education Savings Account in a given year, but only $13,000 is used for the beneficiary’s qualified education expenses in that year. The tax consequence is:

A. $2,000 is taxable
B. $2,000 is taxable and a 10% penalty will be imposed
C. $15,000 is taxable
D. $15,000 is taxable and a 10% penalty will be imposed

Answer 5

The best answer is B.

Since contributions to Coverdell Education Savings Account are not deductible, normally, distributions from a Coverdell Education Savings Account to pay for qualified education expenses are not taxable.

However, if distributions are taken in a given year in excess of the qualified education expenses incurred in that year, then the excess portion is taxable - with the taxable amount being the portion of the distribution that represents the “build-up” in the account above the original contribution amount. This “build-up” was never taxed. In addition, a 10% penalty tax applies as well.

The moral of this tale is, use the money in the account to pay for qualified education expenses only; and use it all up for this purpose!

Question 6

Monies that have accumulated in a Coverdell Education Savings Account that are not used by the beneficiary to pay for qualified educational expenses:

A. may be rolled over into a Traditional IRA without any tax liability
B. may be rolled over into a Roth IRA without any tax liability
C. may be transferred to a Coverdell Education Savings Account for a sibling that so qualifies without any tax liability
D. are tax-deferred until a Traditional IRA is established by the beneficiary

Answer 6

The best answer is C.

Coverdell Education Savings Account permit a maximum annual non-deductible contribution of $2,000 to pay for qualified education expenses. Contributions must cease at age 18. The monies in the account must be used by age 30.

Any unexpended funds in the account can be transferred to another family member for their qualified education expenses (like a younger brother or sister). If the funds are not used by age 30, or transferred to a sibling that so qualified, then they become taxable (the taxable amount is the “build-up” in the account - the amount above the original non-tax deductible contribution).

Question 7

Which statement is TRUE?

A. The name of the beneficiary on a Coverdell ESA cannot be changed to another beneficiary unless the original beneficiary agrees
B. The name of the beneficiary on a Coverdell ESA can be changed to another beneficiary without the consent of the original beneficiary
C. The name of a beneficiary (minor) on a UTMA account can be changed to another beneficiary without the consent of the original beneficiary
D. The name of a beneficiary (minor) on a UTMA account cannot be changed to another beneficiary unless the original beneficiary agrees

Answer 7

The best answer is B.

The donor controls the funds in a Coverdell ESA and the funds can be transferred from one beneficiary to another beneficiary (e.g., transfer of the funds from a daughter who received a full scholarship to an account for a son). Consent of the original beneficiary is not needed.

In comparison, custodial accounts opened under UGMA or UTMA cannot be transferred to another minor - gifts into custodial accounts are irrevocable and cannot be transferred.

Question 8

High-earning individuals can make contributions to:

A. UGMA Accounts
B. Roth IRAs
C. Spousal Roth IRAs
D. Coverdell ESAs

Answer 8

The best answer is A.

Custodial accounts opened under either the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA) can be opened by any adult for any minor, with no limitation on the income of the donor in determining whether the account can be opened.

On the other hand, high-earning individuals are prohibited from opening either a Roth IRA or a Coverdell Education Savings Account.

Question 9

Which of the following is a characteristic of Coverdell ESAs?

A. Can be transferred to any person at any time
B. Transfer is limited to a family member under age 35
C. Tax free distributions are to be used only for educational purposes
D. Tax free distributions can be used for any purpose that benefits the student

Answer 9

The best answer is C.

Coverdell Education Savings Accounts allow for $2,000 a year to be contributed to pay for a child’s education expenses. There is no tax deduction for the contribution and the account grows tax free, as long as the funds are used to pay for school expenses. These are not terribly popular because they are not available to high earners.

The funds in the account must start being used at age 18 (but they can be used earlier than this) and the account must be depleted by age 30. Any undepleted funds at age 30 can be transferred to another family member going to school who is also under age 30.

If there are unused funds at age 30 that are not transferred, they are taxed.

Question 10

Section 529 plans are established by the:

A. state
B. donor
C. recipient
D. custodian

Answer 10

The best answer is A.

State sponsored education savings programs are “Section 529” plans.

Question 11

Which statement about 529 Plans is FALSE?

A. Contribution limits are established by each state
B. Distributions used to pay for qualified higher education expenses are not federally taxable
C. Amounts contributed are generally deductible from federal income tax
D. Earnings in the account grow tax deferred

Answer 11

The best answer is C.

529 Plan contributions are not deductible at the federal level. However, most states that have income taxes allow a deduction for contributions made to a plan established by that state (and a handful of states allow a tax deduction for contributions made to any state’s 529 Plan!). This is a tax benefit of making 529 Plan contributions.

Contribution limits are established by each state. Earnings in the account grow tax deferred. Distributions used to pay for qualified education expenses are tax free.

Question 12

When discussing a 529 Plan with a client, which statement can be made?

A. “There is no limit to the amount that can be contributed to the plan, because, as you know, college is very expensive”
B. “If the beneficiary completes college without all the funds being spent, the unexpended funds can be used to pay for first time home purchase expenses without tax being due”
C. “The amount contributed to the plan will not be deductible from federal income tax, but it is usually deductible from state income tax”
D. Contributions are made into the account with pretax dollars

Answer 12

The best answer is C.

529 Plan contributions are not deductible at the federal level. However, most states that have income taxes allow a deduction for contributions made to a plan established by that state. This is a tax benefit of making 529 Plan contributions.

Each state imposes its own limit on how much can be contributed to a 529 Plan. Any unexpended funds in the account can be given to another family member to pay for their college and maintain tax-deferred status, but if there are funds that are not used, they become taxable (on the growth in the account plus a 10% penalty tax, because the contribution was made with after-tax dollars).

Question 13

Which statement is TRUE about federal taxation of contributions to 529 plans?

A. Contributions are tax deductible to the donor
B. Contributions amounts above the gift tax exclusion amount are taxable to the recipient
C. Contribution amounts above the gift tax exclusion amount are taxable to the donor
D. The full contribution is taxable to the donor

Answer 13

The best answer is C.

Contributions to 529 plans are not federally tax deductible. Any gifts above the annual gift tax exclusion amount ($15,000 in 2019) are subject to gift tax. Gift tax is paid by the donor, not the recipient. Note that a tax benefit offered by 529 plans is a 1-time gift that can be made into the account equal to 5 times the current gift tax exclusion, without the donor worrying about having to pay gift tax. Since the current exclusion is $15,000 in 2019, 5 times this amount or $75,000 can be donated as a 1-time gift and not be subject to gift tax.

Question 14

What type of education savings plan permits an adult donor to be the beneficiary?

A. Custodial account opened under UTMA
B. 529 Plan
C. Coverdell Education Savings Plans
D. Any of the above

Answer 14

The best answer is B.

An unusual feature of 529 Plans is that the donor and the beneficiary can be the same person. There is no age limit on who can be the account beneficiary.

Custodial accounts can only be opened by an adult for a minor. Contributions to a Coverdell Education Savings Account can only be made to someone who is below age 18.

Question 15

Section 529 plans generally permit:

A. tax deductible contributions by the donor
B. tax free withdrawals for first time home buyers
C. taxable distributions to the recipient to pay for higher education
D. non-taxable distributions to the recipient to pay for higher education

Answer 15

The best answer is D.

Any adult can open a Section 529 account to pay for the higher education expenses of a beneficiary. Starting in 2018, up to $10,000 per year can be withdrawn to pay for education below the college level. There is no tax deduction for the contribution; earnings build tax-deferred; and distributions to pay qualified higher education expenses are not taxable.

Question 16

Which statement is FALSE regarding Section 529 Accounts?

A. Any adult can open an account for any beneficiary
B. Account contributions are not deductible, but earnings build tax-deferred
C. Non-taxable distributions may be made to pay for qualified higher education expenses
D. Non-taxable distributions may only be made to educational institutions in the state that sponsors the plan

Answer 16

The best answer is D.

Any adult can open a Section 529 account for a beneficiary. Contributions are not tax deductible, but earnings build tax-deferred. Distributions to pay for qualified higher education expenses are not taxable; and these distributions can be made to any qualified educational institution in any state.

Question 17

Which statement is TRUE?

A. Distributions from a Coverdell ESA and a 529 plan to pay for higher education costs are not taxable
B. Distributions from a Coverdell ESA and a 529 plan to pay for higher education costs are taxable at ordinary income rates
C. Distributions from a Coverdell ESA and a 529 plan to pay for higher education costs are taxable at long term capital gains rates
D. Distributions from a Coverdell ESA and a 529 plan to pay for higher education costs are taxable free as long as the student attends an in-state school

Answer 17

The best answer is A.

Contributions to both Coverdell ESAs and 529 plans are not tax deductible. Earnings build tax-deferred in both. Distributions from both, when used to pay for appropriate educational expenses, are not taxable.

Coverdell ESA distributions can be used without limit to pay for all levels of education. 529 plan distributions can only be used without limit to pay for college and higher; distributions to pay for education below the college level are limited to $10,000 per year.

High earning individuals cannot open a Coverdell; there is no similar restriction on a 529 Plan.

Coverdell ESA contributions are limited to $2,000 per child per year; 529 plan contribution limits are set by each state and are much higher.

Students in either plan are not limited to attending in-state schools.

Question 18

A customer wishes to open an account to fund payment of private middle school tuition. If the customer does not wish to deposit more than $2,000 per year and wishes to get a tax benefit, the best advice is for the customer to open a:

A. 529 Plan
B. Coverdell ESA
C. Trust account
D. UTMA account

Answer 18

The best answer is B.

The question meets the definition for a Coverdell ESA. Any adult can open a Coverdell for a child (as long as the adult’s income is not too high), and the maximum annual contribution of $2,000 is not tax deductible. The account builds tax-deferred. Funds can be withdrawn without tax due to pay for “qualifying” education expenses, which include the cost of elementary, middle school, high school, and vocational school, as well as college costs.

529 plans are typically used to fund college and the contribution amounts are much higher because college is expensive. This type of account would have deposits that are much higher than $2,000 per year.

Trust accounts and UTMA accounts could be used to pay for middle school, but there is no tax-deferral on these accounts - earnings are taxable each year.

Question 19

Aggregate contributions into 529 plans are:

A. subject to dollar limits at both the federal and state level
B. not subject to dollar limits at either the federal or state level
C. only subject to dollar limits at the federal level
D. only subject to dollar limits at the state level

Answer 19

The best answer is D.

There is no aggregate contribution limit on the amount that can be invested in 529 plans at the federal level; though most states have such limits (the intent is that the dollar amount is enough to meet reasonable higher education expenses, but not more than that amount).

Also note that gifts given into a 529 plan will be subject to gift tax paid by the donor if they exceed the annual federal gift tax exclusion amount - $15,000 in 2019.

Question 20

High-earning parents would like to invest in equities to fund their child’s higher education expenses. The best investment choice would be a:

A. 529 College Savings Plan
B. Coverdell Education Savings Account
C. Uniform Gifts to Minors Account
D. Series EE Treasury Bonds

Answer 20

The best answer is A.

High-earning individuals cannot contribute to a Coverdell Education Savings Account.

High earning individuals who invest in U.S. Government Savings Bonds and use the interest to pay for higher education expenses are taxed on the interest at the federal level.

Contributions to custodial accounts are not deductible regardless of income level and the earnings in the account are taxable annually - there is no tax benefit here, regardless of income level.

Investments in 529 Plans are not federally tax-deductible, but the earnings grow tax-deferred, and distributions to pay for qualified higher education expenses are not taxable. This tax benefit is not subject to income phase-out rules, as is the case with Coverdell ESAs and U.S. Government Savings Bond investments to pay for higher education. (The interest earned when Series EE bonds are redeemed to pay for qualified education expenses is tax-free for lower income individuals.)

(Also note that starting in 2018, up to $10,000 per year can be withdrawn from a 529 Plan to pay for education below the college level, but that is not part of this question.)

Question 21

A woman in the highest tax bracket has $105,000 to invest for her teenage child’s college education. She wants to make sure that, if he doesn’t attend college, that he will not have access to these funds. She should be advised to make the investment in a:

A. Coverdell ESA
B. 529 Plan
C. UTMA account
D. Growth mutual fund

Answer 21

The best answer is B.

The keys here are that the parent wishes to maintain control and wishes to save for college. A 529 plan allows the parent to maintain control - the kid has no access to the account. There are no income limits on opening a 529 Plan, and this parent is in the highest tax bracket. She cannot open a Coverdell ESA because these are not available to high earners. An UTMA account would allow the kid to control the account at the age of transfer, so this is not the best choice. A growth mutual fund would be taxable each year, while the purchase of a growth mutual fund in a 529 plan would grow tax free. The 529 plan is the way to go!

Question 22

LGIPs marketed by broker-dealers are investment vehicles offered to:

A. the general public
B. wealthy accredited investors
C. major institutional investors
D. local governmental entities in that state

Answer 22

The best answer is D.

An LGIP is a “Local Government Investment Pool.” It is an investment fund set up under state law that is only offered to local municipal governmental entities in that state. For example, if a town in a state has collected its real estate taxes, but has not yet spent those funds, it can put the balance in that state’s LGIP. The LGIP is managed to provide a safe investment return.

The MSRB takes the stance that if an LGIP retains a broker-dealer to market its offerings in that state, then it is a municipal fund security subject to MSRB rules. On the other hand, if the LGIP uses its own employees to market itself to local state governmental entities, then it is not subject to MSRB rules.

Question 23

An ABLE account:

A. must be established prior to the beneficiary reaching age 18
B. must be established prior to the beneficiary reaching age 21
C. may only pay for the housing expenses incurred by a disabled individual
D. is used to pay for the qualified ongoing expenses incurred by a disabled individual

Answer 23

The best answer is D.

ABLE accounts were enacted by Congress in late 2014. ABLE stands for “Achieving a Better Life Experience Act.” It allows each state to set up a “municipal fund security” regulated by the MSRB that permits an account to be established to pay for the ongoing expenses of a disabled person.

One of the key features of an ABLE account is that accumulated savings do not affect that person’s eligibility for other Federal benefits (it used to be the case that having too much in assets would disqualify that person from other Federal benefits such as Medicaid).

Up to $15,000 per year (the Federal gift tax exclusion amount) can be contributed to an ABLE account, with no tax deduction. The account grows tax-deferred, and payments to pay for qualified expenses are tax-free. Qualified expenses include medical care, transportation, housing, education, and assistive technology.

The account must be established before the disabled individual reaches age 26, and proof that the beneficiary is disabled or blind must be provided.

ABLE accounts are permitted under Section 529A of the Internal Revenue Code. Do not confuse these with 529 Plans, which are a municipal fund security to save for education expenses.

Question 24

All of the following statements are true about Health Savings Accounts EXCEPT:

A. HSAs are only appropriate for those individuals covered by high-deductible health insurance plans
B. HSAs can be set up to include dependents of the covered individual
C. HSA contributions are tax deductible
D. HSA contributions are subject to phase-out when an individual’s income exceeds $250,000

Answer 24

The best answer is D.

Health Savings Accounts (HSAs) were first authorized by Congress starting in the beginning of 2004. They are a tax advantaged medical savings account that is owned by the individual. They are established by corporate employers as part of their health insurance plans, and only plans that have a high deductible can set up HSAs for employees. More employers are adopting these high-deductible plans coupled with HSAs as a way of reducing, or slowing the growth of, their health insurance expenses.

The HSA permits the employer or employee to make a deductible contribution in 2019 of up to $3,500 for a single individual, or $7,000 for a family, to the account. The contribution amount is indexed for inflation annually. The account is invested in a similar manner to an IRA. It grows tax-deferred and withdrawals to pay for qualified medical expenses are tax-free. There are no income phase out rules for HSAs.

Question 25

Which statement is TRUE about HSAs?

A. HSAs have a $2500 maximum annual contribution
B. HSAs have the same contribution limits as IRAs
C. HSAs are funded with tax-deductible contributions
D. HSAs are funded with non tax-deductible contributions

Answer 25

The best answer is C.

Health Savings Accounts (HSAs) were first authorized by Congress starting in the beginning of 2004. They are a tax advantaged medical savings account that is owned by the individual. They are established by corporate employers as part of their health insurance plans, and only plans that have a high deductible can set up HSAs for employees. More employers are adopting these high-deductible plans coupled with HSAs as a way of reducing, or slowing the growth of, their health insurance expenses.

The HSA permits the employer or employee to make a deductible contribution in 2019 of up to $3,500 for a single individual; or $7,000 for a family; to the account. The contribution amount is indexed for inflation annually. The account is invested in a similar manner to an IRA. It grows tax-deferred and withdrawals to pay for qualified medical expenses are tax-free.