LO 8.2.3: Compare the features of edcuation savings vehicles.

Question 1

Historically, what are the 3 means of financing a child’s college education?

Answer 1

• from current income of parents or relatives
• with student loans, grants, or scholarships; or
• from a parent’s or relative’s personal savings

Question 2

Custodial Accounts

Answer 2

Popular way of income shifting and saving for college in a child’s name

Question 3

Uniform Gifts to Minors Act (UGMA)

Answer 3

• First custodial account

* In many states UGMA accts were superseded by those established under the Uniform Transfers to Minors Act (UTMA)

Question 4

What are disadvantages of UGMA and UTMA accounts?

Answer 4

• At age of majority, either 18 or 21 (state law), child could gain access to the funds in account, regardless of whether used to pay for a college education.
• Portability limitation — each acct can only be assigned to another sibling or family member.
  
  • If the funds are not needed tue to scholarship receipt or less-than-expected cost of attendance, the acct cannot be retitled for education costs of another child.

Question 5

What do UGMA and UTMAs allow parents to do?

Answer 5

Put cash and securities in a custodial acct for a child.

Question 6

What may a UTMA acct be funded with?

Answer 6

• Any cash-type asset, including securities and mutual funds, but also real estate (uncommon).

Question 7

Can a UGMA acct be funded with real estate?

Answer 7

No.

Question 8

What is the ownership of UGMA and UTMA accounts?

Answer 8

Parent may be custodian but the child is considered owner of the assets.

Question 9

How are UGMAs and UTMAs included in the EFC calculation?

Answer 9

Will be included at the child’s rate of 20% when calculating EFC.

Question 10

Series EE and I bonds

Answer 10

• If issued after 1989, qualified taxpayers can exclude form their gross income all or a portion of all the interest earned on these saving bond redemptions
• Part of the savings bond education tax exclusion
• Eligible expenses must be incurred during same tax year in which eligible bonds are redeemed

Question 11

How does one qualify for the savings bond education tax exclusion?

Answer 11

• Bondholders must be at least 24 years old when the bond is purchased, and
• the taxpayer, taxpayer’s spouse, or taxpayer’s dependent at certain postsecondary educational institutions must incur tuition and other educational expenses.
• Individuals with incomes above certain thresholds may not be eligible to participate.
  
  • This phaseout restriction will be in place when the distribution occurs, so monitor the client’s income compared to the phaseout.

Question 12

Series EE and I bonds | What are eligible educational expenses?

Answer 12

• Tuition and fees (such as lab fees and other required course expenses) at eligible educational institution
• Qualified state programs

Question 13

Series EE and I bonds | What are non-eligible educational expenses?

Answer 13

Room and board, as well as books.

Question 14

Can Series EE bonds be converted to Section 529 plans?

Answer 14

Yes and tax-free, but there are income restrictions.

Question 15

Series EE and I bonds | Ownership

Answer 15

• Child can be named beneficiary but not co-owner
• Only eligible owners are the taxpayer (purchaser) and their spouse
• Spouses must file a joint tax return to qualify for the tax benefit

Question 16

Series EE and I bonds | What are the income phaseout ranges?

Answer 16

• To determine qualification for the educational tax exclusion:
  
  • $81,100 - $96,100 (single) and
  • $121,600 - $151,600 (married filing jointly) in 2019.
  • There are additional requirements and limitations.

Question 17

Coverdell Education Savings Account (CESA)

Answer 17

• Save for a child’s education expenses
• Total contributions to all CESAs can’t be more than $2,000 (per child) in any given year ($36,000 per child over 18 years)
• Child must be under 18 when contribution is made
• Contributions are not deductible, but
• Earnings accumulate tax free
• When a CESA is distributed and used for the payment of qualified education expenses, the amounts are free from income tax and penalties regardless of the donor’s age.

Question 18

CESA | Qualified Education Expenses

Answer 18

• Higher education,
• Private elementary and secondary education (K-12)
• Tuition and expenses for room and board are permitted.

Question 19

CESA | What type of account registration can the CESA be established as?

Answer 19

The CESA is established either in a trust or custodial account on behalf of the child

Question 20

CESA | What are the contribution limits?

Answer 20

Contributions are limited to $2,000 per year per child, regardless of the number of donors to the acct

Question 21

CESA | Are contributions subject to AGI phaseout?

Answer 21

• Yes, Contributions are subject to phaseout.
• In 2019, this phaseout is $95,000 - $110,000 of modified AGI for single taxpayers and $190,000 - $220,000 of modified AGI for married taxpayers filing jointly
• Currently, the phaseout amt does not adjust for inflation.
• vs. 529 — which do not have any income phaseout.

Question 22

CESA | When must all funds be used by the student?

Answer 22

• All funds within the CESA must be used before the student reaches age 30: elementary, secondary, and college.
• Any remaining funds will be disbursed to the CESA beneficiary, and the earnings will be subject to income tax and a 10% penalty
• To prevent this from occurring, owner of the CESA has the right to change the beneficiary to another member of the family of the original beneficiary.

Question 23

CESA | How many rollovers can take place?

Answer 23

Only one rollover to a 529 for a CESA is allowed per individual per year.

Question 24

Section 529 plan

Answer 24

• AKA. Qualified Tuition Program (QTP)
• Tax-advantaged program that helps family save money for college
• Housed at the state level; there are in-state tax deductions— see if client has a plan at their state-level.

Question 25

529 | Is there an income phaseout?

Answer 25

No.

Question 26

529 | Tax Benefits of Contributions, Earnings, and Withdrawals

Answer 26

• ability to make contributions regardless of the contributor’s AGI,
• tax-free earnings growth, and
• tax-free withdrawals to the extent they are used to pay qualified higher education expenses.

Question 27

529 | What are the qualified distribution limits?

Answer 27

• (after Dec. 31, 2017): BEFORE COLLEGE — tuition at an elementary, or secondary schools (public, private, or religious school), capped at $10,000 tax-free per year
  
  • Any distributions above $10,000 would consist of part earnings and part contributions
  • Earnings portion would be taxed
• FOR COLLEGE, no distribution restrictions for qualified education expenses.

Question 28

529 | is there any restriction to age as to when funds must be dispersed?

Answer 28

No. vs. Coverdell which is by age 30.

Question 29

529 | What are the qualified distribution limits — for college?

Answer 29

• FOR COLLEGE, no distribution restrictions for qualified education expenses.
• Once the student reaches college, 529 plans can be disbursed without limits
• If withdrawals aren’t used for qualified education expenses, 10% penalty tax

Question 30

529 | Who is the owner of QTPs?

Answer 30

In the vast majority of cases the owner of the QTP is the contributor.

Question 31

529 | Contribution Limits

Answer 31

Contribution limits vary from $100K to $250K depending on the state

Question 32

Do beneficiaries of Section 529 plans gain control of the assets at age of majority (as with custodial UGMA and UTMA accts)?

Answer 32

No.

Question 33

529 Plan | What happens if the acct balance is not used for college?

Answer 33

The acct may be rolled over to any family member as defined in the Treasury Regulations for Section 529

Question 34

What are the 2 types of Section 529 (QTP) plans?

Answer 34

1. Prepaid tuition plan

2. College savings plan

Question 35

Prepaid tuition plans

Answer 35

• Prepay future tuition at today’s tuition rates or

* Purchase tuition credits (units) to apply to future tuition costs

Question 36

Prepaid tuition plans | Qualified expenses

Answer 36

Tuition and mandatory fees only

Question 37

Prepaid tuition plans | What type of college must the student attend?

Answer 37

• Any public college or university within the state (or the specific private institution) that established the QTP
• If the student attends a college or university not covered by the prepaid tuition plan, provisions are made to pay a sum for that purpose, although the payment will likely not be an equal amount.
• Becoming less common: 18 states once offered plans, the number is now 11.

Question 38

College savings plans

Answer 38

• May be offered only states, state-sponsored organizations, and eligible educational institutions
• Contribution rules are the same as those for the prepaid tuition plans
• (Not a tuition prepayment) A tax-advantaged savings plan.
• Tax-free distributions to qualified education expenses.

Question 39

College savings plans | Types of Investments

Answer 39

• Investment options often include:
  
  • Stock mutual funds,
  • Bond mutual funds, and
  • Money market funds
• Some plans offer age-based portfolios that automatically shift toward more conservative investments as the beneficiary gets closer to college age.

Question 40

What are the advantages of a college savings plan over the prepaid tuition plan?

Answer 40

• College savings plan does not restrict where the child beneficiary may attend college
  
  • The private savings plan permits open enrollment and is available for either out-of-state public university costs or private university costs w/o any loss of acct value
• Prepaid tuition plans are established solely for tuition and mandatory fees
• College Savings Plans may be used for qualified educational expenses beyond tuition and fees
  
  • Include tuition, fees, books, or supplies required for attendance and room and board (if student is attending at least half time)
• Unlike the prepaid tuition plan, funds in the college savings plan are not guaranteed by the sponsoring state, and if the contributor is unhappy with the performance of the college savings plan, the only real alternative is to roll over the acct to a different college savings plan.

Question 41

Prepaid Tuition Plan | Key points

Answer 41

• Inflation-based performance
• Suitable for risk-averse investor
• May offer state-guaranteed return on assets
• Usually restricted enrollment options
• Public in-state: May restrict out-of-state tuition costs and, if less than in-state, may not refund difference
• Covers tuition and mandatory fees only

Question 42

College Savings Plan | Key points

Answer 42

• Market-based performance
• Suitable for risk-tolerant investor
• No state-guaranteed return on assets
• Open enrollment
• Public or private: Available for out-of-state tuition costs without any refund difference
• In addition to tuition and mandatory fees— covers books, required supplies, and room and board (students attending at least half time)

Question 43

UGMA 529 or UTMA 529 Plan

Answer 43

Most states that have a previously established 529 QTP plan will permit a contributor to roll over UGMA or UTMA proceeds to the 529 plan.

Question 44

ABLE Accounts

Answer 44

• AKA. Achieving a Better Life Experiencing Act of 2014, or ABLE Act, created ABLE accts
• Pay for qualified disability-related expenses
• Contributions may be made by the person with a disability (designated beneficiary), parents, family members, or others
• Annual limit on contributions is the gift tax exemption ($15K in 2019)

Question 45

What are provisions for the designated beneficiary of an ABLE account?

Answer 45

• For tax years before Jan. 1, 2026, after the limit (annual gift tax exemption amt) is reached, the ABLE acct’s designated beneficiary can contribute an additional amt up to the lesser of
  
  • 1. the federal poverty line for a one-person household or
  • 2. the individual’s compensation for the tax year
• The designated beneficiary can also claim the saver’s credit for contributions made to this ABLE acct.
• (or person acting on the beneficiary’s behalf) Must maintain adequate records for ensuring compliance with the limitations.

Question 46

Can distributions from QTPs be rolled over to an ABLE account?

Answer 46

Yes, and without penalty, provided that the ABLE acct is owned by same beneficiary or member of family.

Question 47

Are rolled over amounts from a QTP to an ABLE account counted toward the ABLE contribution limit?

Answer 47

• Rolled over amounts count toward the contribution limit to an ABLE acct within a tax year, and
• any amt rolled over in excess of this limitation is includible in the gross income of the distributee.

Question 48

Income shifting

Answer 48

• A process typically accomplished by either transferring funds directly to the minor child’s control or
• establishing a custodial or trust arrangement on behalf of the child.

Question 49

Direct Transfer - Income shifting

Answer 49

• A direct transfer of assets into the child’s name is simple, inexpensive, and may avoid taxation of the income at the parent’s or donor’s presumably higher marginal tax rate.
• Also works well if certain investments are the subject of the gift (e.g., stocks that have significantly appreciated in value)
  
  • For gifted direct transfers- taxes may be deferred until the child is of college age.

Question 50

Custodial Accounts - Income shifting

Answer 50

• Custodial accts are another way of building a college funds
• AKA. a poor man’s trust - since they have virtually no administrative costs
• Involve naming an individual as the manager of property belonging to a minor child.
• Are not trusts, but are accounts.
• Two types: UGMA, UTMA

Question 51

Do all states have UGMAs and UTMAs?

Answer 51

• No, some states may only allow one type of custodial account, while others may allow either or both.
• Individual state laws should be consulted to determine effect on your state.

Question 52

Why is a custodianship preferable to a direct transfer of property to minor for most parents?

Answer 52

• Almost any type of property can be placed under a custodian’s care;
• however, in states where only the UGMA has been adopted, some restrictions on permissible investments may apply.

Question 53

What are the disadvantages of a custodial arrangement?

Answer 53

• The child or beneficiary must be given the right to possession of the property upon age of majority.
• This must occur even though the child may choose not to use the funds for a college education.
• Relatively inflexible for avoiding the “kiddie tax”
• A formal trust may be better to minimize these problems.

Question 54

Kiddie tax

Answer 54

• Applies to unearned (i.e., investment) income greater than $2,200 (in 2019) received by children under age 19, or under age 24 if a full-time student.
• The first $1,100 of unearned income is not taxed bc it is offset by the standard deduction;
• The second $1,100 of unearned income is taxed at the child’s marginal rate; and
• All unearned income exceeding $2,200 is taxed at the estates and trusts marginal income tax brackets.
• May make Section 529 plans and CESAs more beneficial from a tax standpoint because there are increased ages at which the kiddie tax is likely to have an impact.

Question 55

How does the kiddie tax affect how education funding accounts should be structured?

Answer 55

Investment vehicles selected for education funding when the child is subject to the kiddie tax should be structured for growth rather than income, to avoid the kiddie tax.

Question 56

What are the 3 basic forms of trusts used in college education funding?

Answer 56

1. A minor’s trust, established under the provisions of Internal Revenue Code (IRC) Section 2503(c)
2. A current income trust, structured according to the terms of IRC Section 2503(b)
3. A demand, or Crummey invasion trust

Question 57

Minor’s trust [2503(c)]

Answer 57

• Designed to use the $15K ($30K for married couple using gift splitting) annual gift tax exclusion for 2019
• Although it may permit the accumulation of income on behalf of the child under the trust terms.
• If money is put into this kind of trust for a child, potential taxes may be higher than the child’s or parent’s tax brackets.
• The funds must be given to the child at 21.

Question 58

Current income trust [2503(b)]

Answer 58

• Must have its income paid out at least annually to the beneficiary with no discretion left to the trustee to accumulate income
• This typically presents problems in avoiding the kiddie tax; advantage to many grantors
• The trust property doesn’t need to be distributed at any age
• Segregated funds can only be used for what they are intended
• Choose investments that increase in value but do not pay income while the child is young; without this approach, all of the income earned in the trust will be paid to the child, and the fund will not grow.

Question 59

Crummey invasion trust

Answer 59

• The demand, or Crummey invsaion, trust
• An effective mix of the best attributes of the minor’s and current income trusts
• Transfers money from one individual to a trust for the benefit of another
• Avoids gift taxes, keeps the money out of the estate of the donor
• Permits the beneficiary to withdraw from the trust an amt equal to the lesser of
  
  • the annual addition to the trust or
  • the annual gift tax exclusion.
• The demand trust allows distribution at any age chosen by the grantor.
• However, if the demand trust accumulates income and it is taxed to the trust itself, the tax is high.

Question 60

Can a parent use their qualified retirement plan to fund college expenses?

Answer 60

• Yes, preretirement money with no 10% penalty IFF:
  
  • the participant withdraws roughly equal amounts from the plan annually for at least 5 years following commencement of distributions, - or - until reaching age 59 1/2 (whichever is later);
  • the retirement money c an be used for any reason.
• Advisable only if the client is overfunded for retirement.
• Appropriate if the client has extremely large qualified plans that will require substantial RMDs in the future and a large estate.

Question 61

Can a parent use their IRA to fund college expenses?

Answer 61

• Yes, and without the 10% early withdrawal penalty for qualified higher education expenses for the taxpayer, spouse, children, or grandchildren.
• Any amount withdrawn will be taxed as ordinary income the year it was received.

Question 62

Can a parent use a Roth IRA to fund college expenses?

Answer 62

• Yes, if the account has been owned for 5 years and a qualified reason exists, the owner can withdraw earnings without penalty, but
• Earnings will be taxed if the distributions exceed the contributions.
• Earnings can only be withdrawn tax-free from a Roth at age 59 1/2.
• Roth IRAs are good as a supplement to Section 529 plans.