tackling the most difficult 529 questions joseph hurley cpa savingforcollege.com september 2011
TRANSCRIPT
Tackling the Most Difficult 529 Questions
Joseph Hurley CPASavingforcollege.com
September 2011
529 Universe95 savings programs
60 direct-sold 529 savings programs 35 advisor-sold 529 savings programs Over 3,000 portfolios
20 prepaid tuition programs 10 state-sponsored 529 1 state-sponsored non-529 (MA U.Plan) 1 institutional (PC 529) 8 “closed” prepaid programs
Industry Growth
• $149.8B at 6/30/11– Up 2.4% from 3/31/11– Up 27% from 6/30/10
• 2/3rds of assets are in age-based portfolios
Source: Data compiled by Financial Research Corporation (FRC) for the College Savings Foundation (CSF)
10-Year Growth of 529 Plan Assets
529 Asset Breakdown by Distribution Method, 2003-2010
Legislative Status
• H.R. 529 introduced February 20111. Reinstates computer technology as QHEE2. Allows 4 investment changes/year3. Up to $600 in tax-free employer matching4. Make 529 contributions eligible for Saver’s Credit– Prospects unclear, some parts may attach to other
bills
• Budget deficit negotiations– No indication that 529 plans will be targeted
“Why can’t you just tell me which is the best 529 plan?”
Consider:• Confidence in investment manager
– Single-manager versus multi-manager• Investment menu• Investment performance
– Savingforcollege.com Quarterly 529 Rankings• Fees and expenses
– Savingforcollege.com Fee Study• Flexibility – e.g. owner changes• Wholesaler knowledge/resources• In-state benefits?
“Why shouldn’t I use a Roth IRA instead of a 529 to save for college?”
Roth Pros
• No tax/penalty on withdrawal of contributions– Contributions come out first with Roth– Can use for any purpose versus the 10% penalty
with 529 plan• Early distribution penalty waived with
qualified higher education expenses• Availability of self-directed accounts• Retirement accounts not reported as assets
on FAFSA
Roth Cons
• Who cares that the IRA penalty is waived?– Earnings are taxed versus tax-free 529
• Can’t put in very much– $5-6,000 annual Roth contribution limit versus
$300,000+ with 529– Earned income requirement
• Using for college means not using for retirement• IRA distributions are added back as based-year
income on the FAFSA– Assessed as high as 50% in computing EFC
“How can I convince the Grandmother to turn over her 529 plan to me?”
You could ask her:
• Don’t you trust me with the account?• Don’t you realize what will happen if you ever
have to apply for Medicaid?– State will require use of 529 for medical expenses
• Don’t you realize what will happen if Sally becomes eligible for need-based financial aid?– Distributions from grandparent-owned 529 must
be added back to student’s base-year income
If she says MYOB
• Ask to use her account first in paying college bills– Reduces the risk of her circumstances changing
• Ask her to use her account last in paying college bills– Distributions for final year of college will not
impact aid
• Ask her again next year for owner change
“I have two children. Should I set up one 529 account or two?”
Suggest 2 accounts:
• Two $13K annual gift exclusions instead of one
• Tailor the asset allocation for each child’s age• Better family bookkeeping
– No second guessing if account owner dies – No hard feelings if “left out” child opens the 529
statements• Could possibly save $10 - $50 per year in
annual account maintenance with 1 account
“I’ve heard you have 33 different 529 plans. Should I open multiple plans for
my child?”
Reasons for two or more plans:
• Investment manager diversification• Prefer in-state 529 only for its limited tax
benefit– Additional amounts to a better or cheaper 529
• See how different 529 plans are run• Asset class segregation
– Each account has its own earnings ratio– Minimize risk of future taxes/penalties by leaving
lower-earning 529 for last
Reasons for just one plan:
• Much easier, less confusing, less paperwork• Can usually find sufficient diversification in
one 529 plan• Asset class segregation usually isn’t worth the
effort– Expect it all to come out tax-free anyway
“What is this I hear about 529 distributions being taxed even when
used for college?”
Tax coordination rules (aka anti-double-dipping)
• Tax credit expenses reduce the pool of 529-eligible expenses– QHEE versus AQHEE (see IRS Publication 970)
• American Opportunity credit– Up to $4,000 reduction in QHEE ($2,500 max credit)
• Lifetime Learning credit– Up to $10,000 reduction in QHEE ($2,000 max credit)
• 10% penalty is waived on resulting income• Above-the-line tuition deduction may have to be
reduced for 529 tax-free distributions
Tax coordination example
Total LLC 529
Tuition and fees
$12,000 $10,000 $2,000
Room and board
$10,000 N/A $10,000
Books, supplies, equipment
$1,000 N/A $1,000
Total $23,000 $10,000 $13,000
AQHEE Strategies
• Pay out-of-pocket (non-529) for AO/Hope/Lifetime credit expenses to keep 529 100% tax-free– May impact decision of how much to contribute
to 529 plans
• Taxpayer may forego AO/Hope/Lifetime credits to keep 529 100% tax-free– Rarely a beneficial strategy
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“Doesn’t the $5 million estate exemption pretty much negate the
estate planning advantage of 529s?”
One word:
REVOCABLE
Example with $5M Exemption
• Example: Mr. & Mrs. Smith• Combined $12 million gross estate
• 3 children, 10 grandchildren• No prior use of lifetime exemption• Already using $13,000 gift-tax annual exclusions
with existing life insurance trust
• Attorney suggests a $10M combined gift prior to 12/31/12
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Expect Reluctance
What wealthy couple would want to irrevocably give away 10/12ths of their estate?
By using 529 plans, much of the gift can be made revocable
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Example Outcome
• $300,000 to each grandchild’s 529 account• 10 separate accounts• Total of $3 million to 529 plans (REVOCABLE)• Total of $7 million to trust (IRREVOCABLE)
• Remain in complete control of the 529 accounts
• Less reluctance to follow through with plan
Savingforcollege.com ®, Copyright © 2011 JFH Innovative LLC., All Rights Reserved.
“What can I do if I have already used my once-per-year investment
change?”
Investment change options:
• Wait ‘till January 1– Best time to make change is December
• Change the beneficiary– Can always change back
• Roll over to another 529 plan– Once-per-12-months rule– Change the beneficiary to avoid rollover
restriction
“How do I compute room and board expenses?”
QHEE
• Easy enough:– Tuition and mandatory fees– Required books, supplies, equipment– Special needs expenses of a special needs
beneficiary
• Do not include:– Transportation; repayment of student loans;
computer technology after 2010 that is not required
Room and board
• Actual amount charged for on-campus R&B• Partial meal plan?
– Documented add’l expenses up to full meal plan?• Off-campus housing?
– School’s COA allowance for that category of off-campus R&B
• Students living at home with parents• Students not living at home with parents
• How to split shared housing costs?– Use reasonable approach to achieve the R&B limit
“Can I take a tax-free distribution from my 529 plan to buy a Corvette?”
No tracing required
• 529(c)(3)(b): “Distributions For Qualified Higher Education Expenses … if such distributions do not exceed the qualified higher education expenses … no amount shall be includible in gross income …”
• Publication 970: “No tax is due on a distribution from a QTP unless the amount distributed is less than the beneficiary’s adjusted qualified education expenses.”
“Does it matter who I have the distribution from a 529 plan made
to?”
Distributee choices
• Usually best: the beneficiary– 1099 to beneficiary minimizes tax risk, IRS risk
• Sometimes best: the school– 1099 to beneficiary– Eliminates risk of mistiming the years– But might cause school to adjust financial aid
• Usually the worst: the account owner– 1099 to account owner attracts IRS notices– Income and gift tax issues
“Can I set up an account for unborn child?”
Naming yourself as 529 beneficiary
• No gift until you name a different beneficiary– Stays in gross estate
• No time or age-limits means one account can be used over many generations
• Deemed gift anytime beneficiary is changed to a lower-generation beneficiary– Current: gift from old bene to new bene– IRS may change that
“Are there any tax consequences of changing account owner?”
Answer: Apparently no.
• No income tax consequences• No gift, estate tax consequence• So what is the result:
– Rich parent wants to shift estate to child without transfer tax consequences.
– Establishes 1,000 accounts for every child in the high school (contributes $65 million).
– Then changes account owner on all accounts to child.– Child then liquidates all accounts and pockets the $65
million.
“What does the IRS consider to be abusive with 529 plans?”
Answer: They know it when they see it.
Leveraging Exclusions
Grandparent
Grandchild
Father Mother$13,000
$13,000 $13,000
$13,000 $13,000
$39,000 ABUSIVE?
“Can I use multiple 529 plans for the purpose of contributing millions of
dollars for one beneficiary?”
Answer: Not advisable
• No apparent prohibitions– Aggregation of accounts between states not required– No penalty for high balances in 529 plans
• But consider the risks:– IRS challenge on unknown grounds– IRS rulemaking that is retroactive– Tax and penalties if withdrawn non-qualified– 529 plan cancelling the account and returning balance
“Does it still make sense to use a UTMA for college savings?”
Kiddie Tax After 2007
• Who is subject?– Age 17 or under (same as 2007)– Age 18 AND earned income does not exceed ½ of total support– Age 19 to 23 AND a full-time student AND earned income does
not exceed ½ of total support
• How does it work?– Up to $1,900 of unearned income is child’s bracket
• 0% on first $950, 10% on next $950
– Above $1,900 of unearned income is parents’ bracket
UTMA and Financial Aid
• EFC includes 20% of a non-529 UTMA– EFC may include 50% of any taxable
interest/dividends/gains from the non-529 UTMA• EFC includes only 5.64% or less of a 529 UTMA
– EFC does not add back any of the tax-free 529 distributions
• Conversion of non-529 UTMA to 529 UTMA provides immediate lowering of EFC– But watch for gains triggered by the conversion
“Can I use a 529 to regain control of my child’s UTMA assets?”
Custodian considerations
• Taking funds out of a UTMA does not end the legal custodianship
• Most 529 plans offer custodial 529 accounts– Restrictions imposed to preserve use for the one
beneficiary
• Consider the “spend-down” alternative– End up with parent-owned 529
“Can my spouse and I open a joint account in a 529 plan?”
Joint versus individual ownership
• Most plans do not permit joint accounts• Not important for succession purposes
– Successor owner is named on application
• Could be important in divorce • Or not:
– Zuchowski v. Zuchowski, New York Appellate Division, Second Department (6/7/2011)
“Can an existing educational trust invest in a 529 plan?”
Placing 529 Within a Trust
• Tax savings– Compressed tax brackets in trusts
• Continuing 529 account management– Donor’s death, disability or incompetence
• Attorney and accountant involvement– Prudent investor rules– Fiduciary income tax rules– GST tax issues
• Cautions: financial aid, state income tax, penalty on funds withdrawn to pay trustee fees
“How would the 5-year election work on a $30,000 contribution?”
5-year election: rules
• 20% each year: $6K gift for this year and each of the next 4 years– No flexibility with the spread– Must file Form 709 to make election
• $13K - $6K = $7K remaining exclusion• Year 2 would allow $7K x 5 = $35K additional
contribution with another 5-year election• If annual exclusion increases to $14K, then
$8K x 5 = $40K additional contribution
Multiple 5-Year ElectionsYear 1 Year 2 Year 3 Total
Contribution $30,000 $25,000 $15,000 $70,000
Year 1 gift $6,000 $6,000
Year 2 gift $6,000 $5,000 $11,000
Year 3 gift $6,000 $5,000 $3,000 $14,000
Year 4 gift $6,000 $5,000 $3,000 $14,000
Year 5 gift $6,000 $5,000 $3,000 $14,000
Year 6 gift $5,000 $3,000 $8,000
Year 7 gift $3,000 $3,000
Note: In this example, total gifts in years 3, 4, and 5 exceed the current annual exclusion amount of $13,000 and would result in taxable gifts..
“Why would a charitable organization ever want to open up its own 529
account?”
For Use with Financial Advisors Only, not to be shown to or used with the general
public.© Copyright 2008 Savingforcollege.com,
LLC.
501(c)(3) Accounts
• Useful for funding scholarship programs– Name the beneficiaries at time of awards– No maximum contribution limits
• Professional management of assets– May reduce fiduciary liability of board
• Expand charitable programs– Charities without a scholarship program can
easily start and fundraise for one
Bonus questions
“Who should I name as successor owner: my beneficiary, my spouse, or
a trust?”
Answer: Depends on circumstances.
“Is income from a 529 plan subject to the kiddie tax?”
Answer: Yes.
“How does a 529 plan affect my ability to claim my child as a dependent?”
Answer: Uncertain.
“How much creditor protection do I get if I buy a 529 plan that offers
creditor protection?”
Answer: Untested.
“Can I use the scholarship exception to the 10% penalty for scholarships
received in prior years?”
Answer: Apparently yes.
“Should I roll over my Coverdell ESA to a 529 plan?”
Answer: No hurry.
“How do I know if a particular college is an eligible institution?”
Answer: Can students apply for federal Stafford Loans?
“Can I use the disability exception to the 10% penalty if my child is shown to
have a learning disability?”
Answer: Probably no.
“Can I claim a loss on my 529 plan?”
Answer: Misc. itemized deduction upon complete liquidation.
“Can I provide 529 plans for my employees’ children?”
Answer: It’s still compensation to your employee.
“Can I get a state tax deduction for rollover contributions?”
Answer: No in PA, yes in some states.
“If I make a contribution to the 529 plan owned by my son, who makes the
gift, me or my son?”
Answer: You the contributor.
“Why would a grandparent want to use a 529 plan for estate reduction when 2503(e) is
available?”
Answer: Do both.
“Which is better: a prepaid tuition plan or a 529 savings plan?”
Answer: Depends on circumstances.
“Should I use up my 529 plan as quickly as possible, or spread it evenly
over the college years?”
Answer: Use up old account, start new account.
“What happens if my daughter drops out of school and receives a refund
after I withdraw from the 529 plan?”
Answer: Not clear.
