Category: Education

529 Plans are a Strategy for Estate Planning

529 Plans are a Strategy for Estate Planning

Parents and grandparents use 529 education savings plans to help with the cost of college expenses. However, 529 plans are a helpful strategy for estate planning, according to a recent article, “Reap The Recently-Created Planning Advantages Of 529 Plans” from Forbes.

There’s no federal income tax deduction for contributions to a 529 account. However, 35 states provide a state income tax benefit—a credit or deduction—for contributions, as long as the account is in the state’s plan. Six of those 35 states provide income tax benefits for contributions to any 529 plan, regardless of the state it’s based in.

Contributions also receive federal estate and gift tax benefits. A contribution qualifies for the annual gift tax exclusion, which is $16,000 per beneficiary for gifts made in 2022. Making a contribution up to this amount avoids gift taxes and, even better, doesn’t reduce your lifetime estate and gift tax exemption amount.

Benefits don’t stop there. If it works with the rest of your estate and tax planning, in one year, you can use up to five years’ worth of annual gift tax exclusions with 529 contributions. You may contribute up to $80,000 per beneficiary without triggering gift taxes or reducing your lifetime exemption.

You can, of course, make smaller amounts without incurring gift taxes. However, if this size gift works with your estate plan, you can choose to use the annual exclusion for a grandchild for the next five years. Making this move can remove a significant amount from your estate for federal estate tax purposes.

While the money is out of your estate, you still maintain some control over it. You choose among the investment options offered by the 529 plan. You also have the ability to change the beneficiary of the account to another family member or even to yourself, if it will be used for qualified educational purposes.

The money can be withdrawn from a 529 account if it is needed or if it becomes clear the beneficiary won’t use it for educational purposes. The accumulated income and gains will be taxed and subject to a 10% penalty but the original contribution is not taxed or penalized. It may be better to change the beneficiary if another family member is more likely to need it.

As long as they remain in the account, investment income and gains earned compound tax free. Distributions are also tax free, as long as they are used to pay for qualified education expenses.

In recent years, the definition of qualified educational expenses has changed. When these accounts were first created, many did not permit money to be spent on computers and internet fees. Today, they can be used for computers, room, and board, required books and supplies, tuition and most fees.

The most recent expansion is that 529 accounts can be used to pay for a certain amount of student debt. However, if it is used to pay interest on a loan, the interest is not tax deductible.

Finally, a 2021 law made it possible for a grandparent to set up a 529 account for a grandchild and distributions from the 529 account are not counted as income to the grandchild. This is important when students are applying for financial aid; before this law changed, the funds in the 529 accounts would reduce the student’s likelihood of getting financial aid.

Two factors to consider: which state’s 529 is most advantageous to you and how it can be used as part of a strategy for your estate planning. If you would like to learn more about 529 plans, please visit our previous posts. 

Reference: Forbes (Oct. 27, 2022) “Reap The Recently-Created Planning Advantages Of 529 Plans”

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A Few Ways to Transfer Home to Your Children

A Few Ways to Transfer Home to Your Children

There are a few ways to transfer your home to your children. Kiplinger’s recent article entitled “2 Clever Ways to Gift Your Home to Your Kids” explains that the most common way to transfer a property is for the children to inherit it when the parent passes away. An outright gift of the home to their child may mean higher property taxes in states that treat the gift as a sale. It’s also possible to finance the child’s purchase of the home or sell the property at a discount, known as a bargain sale.

These last two options might appear to be good solutions because many adult children struggle to buy a home at today’s soaring prices. However, crunch the numbers first.

If you sell your home to your child for less than what it’s worth, the IRS considers the difference between the fair market value and the sale price a gift. Therefor., if you sell a $1 million house to your child for $600,000, that $400,000 discount is deemed a gift. You won’t owe federal gift tax on the $400,000 unless your total lifetime gifts exceed the federal estate and gift tax exemption of $12.06 million in 2022, However, you must still file a federal gift tax return on IRS Form 709.

Using the same example, let’s look at the federal income tax consequences. If the parents are married, bought the home years ago and have a $200,000 tax basis in it, when they sell the house at a bargain price to the child, the tax basis gets split proportionately. Here, 40% of the basis ($80,000) is allocated to the gift and 60% ($120,000) to the sale. To determine the gain or loss from the sale, the sale-allocated tax basis is subtracted from the sale proceeds.

In our illustration, the parent’s $480,000 gain ($600,000 minus $120,000) is non-taxable because of the home sale exclusion. Homeowners who owned and used their principal residence for at least two of the five years before the sale can exclude up to $250,000 of the gain ($500,000 if married) from their income.

The child isn’t taxed on the gift portion. However, unlike inherited property, gifted property doesn’t get a stepped-up tax basis. In a bargain sale, the child gets a lower tax basis in the home, in this case $680,000 ($600,000 plus $80,000). If the child were to buy the home at its full $1 million value, the child’s tax basis would be $1 million.

Another way to transfer your home to your children is to combine your bargain sale with a loan to your child, by issuing an installment note for the sale portion. This helps a child who can’t otherwise get third-party financing and allows the parents to charge lower interest rates than a lender, while generating some monthly income.

Be sure that the note is written, signed by the parents and child, includes the amounts and dates of monthly payments along with a maturity date and charges an interest rate that equals or exceeds the IRS’s set interest rate for the month in which the loan is made. Go through the legal steps of securing the note with the home, so your child can deduct interest payments made to you on Schedule A of Form 1040. You’ll have to pay tax on the interest income you receive from your child.

You can also make annual gifts by taking advantage of your annual $16,000 per person gift tax exclusion. If you do this, keep the gifts to your child separate from the note payments you get. With the annual per-person limit, you won’t have to file a gift tax return for these gifts. If you would like to learn more about managing property in your estate planning, please visit our previous posts. 

Reference: Kiplinger (Dec. 23, 2021) “2 Clever Ways to Gift Your Home to Your Kids”

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What is the Best Way to Leave Money to Children?

What is the Best Way to Leave Money to Children?

Parents and grandparents want what’s best for children and grandchildren. We love generously sharing with them during our lifetimes—family vacations, values and history. If we can, we also want to pass on a financial legacy with little or no complications, explains a recent article titled “4 Tax-Smart Ways to Share the Wealth with Kids” from Kiplinger. What is the best way to leave money to children?

There are many ways to transfer wealth from one person to another. However, there are only a handful of tools to effectively transfer financial gifts for future generations during our lifetimes. UTMA/UGMA accounts, 529 accounts, IRAs, and Irrevocable Gift Trusts are the most widely used.

Which option will be best for you and your family? It depends on how much control you want to have, the goal of your gift and its size.

UTMA/UGMA Accounts, the short version for Uniform Transfers to Minor or Uniform Gift to Minor accounts, allows gifts to be set aside for minors who would otherwise not be allowed to own significant property. These custodial accounts let you designate someone—it could be you—to manage gifted funds, until the child becomes of legal age, depending on where you live, 18 or 21.

It takes very little to set up the account. You can do it with your local bank branch. However, the funds are taxable to the child and if an investment triggers a “kiddie tax,” putting the child into a high tax bracket and in line with income tax brackets for non-grantor trusts, it could become expensive. Your estate planning attorney will help you determine if this makes sense.

What may concern you more: when the minor turns 18 or 21, they own the account and can do whatever they want with the funds.

529 College Savings Accounts are increasingly popular for passing on wealth to the next generation. The main goal of a 529 is for educational purposes. However, there are many qualified expenses that it may be used for. Any income from transfers into the account is free of federal income tax, as long as distributions are used for qualified expenses. Any gains may be nontaxable under local and state laws, depending on which account you open and where you live. Contributions to 529 accounts qualify for the annual gift tax exclusion but can also be used for other gift and estate tax planning methods, including letting you make front-loaded gifts for up to five years without tapping your lifetime estate tax exemption.

You may also change the beneficiary of the account at any time, so if one child doesn’t use all their funds, they can be used by another child.

From the IRS’ perspective, a child’s IRA is the same as an adult IRA. The traditional IRA allows an immediate deduction for income taxes when contributions are made. Neither income nor principal are taxed until funds are withdrawn. By contrast, a Roth IRA has no up-front tax deduction. However, any earned income is tax free, as are withdrawals. There are other considerations and limits.  However, generally speaking the Roth IRA is the preferred approach for children and adults when the income earner expects to be in a higher tax bracket when they retire. It’s safe to say that most younger children with earned income will earn more income in their adult years.

The most versatile way to make gifts to minors is through a trust. This is perhaps the best way to leave money to children. There’s no one-size-fits-all trust, and tax rules can be complex. Therefore, trusts should only be created with the help of an experienced estate planning attorney. A trust is a private agreement naming a trustee who will manage the assets in the trust for a beneficiary. The terms can be whatever the grantor (the person creating the trust) wants. Trusts can be designed to be fully asset-protected for a beneficiary’s lifetime, as long as they align with state law. The trust should have a provision for what will occur if the beneficiary or the primary trustee dies before the end of the trust. If you would like to learn more about how to leave money, or an inheritance, to your children, please visit our previous posts.

Reference: Kiplinger (May 15, 2022) “4 Tax-Smart Ways to Share the Wealth with Kids”

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Using HEMS language in a Trust

Being named a trustee comes with a lot of responsibilities and can feel overwhelming. There are protocols in place to help called the HEMS standard. The HEMS standard is used to inform trustees as to how and when funds should be released to a beneficiary, according to a recent article from Yahoo! News, “What is the HEMS Standard in Estate Planning.” Using HEMS language in a trust gives the trustee more control over how assets are distributed and spent. If a beneficiary is young and not financial savvy, this becomes extremely important to protecting both the beneficiary and the assets in the trust. Your estate planning attorney can set up a trust to include this feature.

When a trust includes HEMS language, the assets may only be used for specific needs. Health, education or living expenses can include college tuition, mortgage, and rent payments, medical care and health insurance premiums.

Medical treatment may include eye exams, dental care, health insurance, prescription drugs and some elective procedures.

Education may include college housing, tuition, technology needed for college, studying abroad and career training.

Maintenance and Support includes reasonable comforts, like paying for a gym membership, vacations and gifts for family members.

The HEMS language provides guidance for the trustee. However, ultimately the trustee is vested with the discretionary power to decide whether the assets are being used according to the directions of the trust.

Sometimes beneficiary requests are straightforward, like college tuition or health insurance bills. However, maintenance and support need to be considered in the context of the family’s wealth. If the family and the beneficiary are used to a lifestyle that includes three or four luxurious vacations every year, a request for funds used for a ski trip to Spain may not be out of line. For another family and trust, this would be a ludicrous request.

Having HEMS language in the trust limits distribution. It has greater value, if the trustee is also a beneficiary, lessening the chances of the trust diminishing for non-essentials or to fund a lavish lifestyle.

Giving the trustee HEMS language narrows their discretionary authority enough to help them do a better job of managing assets and may limit challenges by beneficiaries.

Using HEMS language in a trust can be as broad or narrow as the grantor wishes. Just as a trust is crafted to meet the specific directions of the grantor for beneficiaries, the HEMS language can be created to establish a trust where the assets may only be used to pay for college tuition or career training.

Reference: Yahoo! News (Jan. 7, 2022) “What is the HEMS Standard in Estate Planning”

 

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a lot of flexibility in 529 education plans

A lot of Flexibility in 529 Education Plans

Statecollege.com’s recent article entitled “Did You Know 529s Are Powerful Estate Planning Tools?” explains that specialized savings accounts, informally referred to as 529s, could be at the top of your list. There is a lot of flexibility in 529 education plans. These accounts have a number of advantages for beneficiaries. There are also benefits for the donors in the high maximum contribution limits and tax advantages.

Special tax rules governing these accounts let you decrease your taxable estate. That might minimize future federal gift and estate taxes. In 2021, the lifetime exclusion is now $11.7 million per person, so most of us don’t have to concern ourselves with our estates exceeding that limit. However, remember that the threshold will revert back to just over $5 million per person in 2026.

Under the rules that govern 529s, you can make a lump-sum contribution to a 529 plan up to five times the annual limit of $15,000. As a result, you can give $75,000 per recipient ($150,000 for married couples), provided you document your five-year gift on your federal gift tax return and don’t make any more gifts to the same recipient during that five-year period. You can, however, go ahead and give another lump sum after those five years are through. The $150,000 gift per beneficiary won’t have a gift tax, as long as you and your spouse follow the rules.

Many people think that gifting a big chunk of money in a 529 means they’ll irrevocably give up control of those assets. However, a lot of  the flexibility in 529 education plans is allowing you to have considerable control—especially if you title the account in your name. At any time, you can get your money back, but it will be part of your taxable estate again subject to your nominal federal tax rate. There’s also a 10% penalty on the earnings portion of the withdrawal, if you don’t use the money for your designated beneficiary’s qualified education expenses.

If your chosen beneficiary doesn’t need some or all of the money you’ve put in a 529, you can earmark the money for other types of education, like graduate school. You can also change the beneficiary to another member of the family as many times as you like. This is nice if your original beneficiary chooses not to go to college at all.

In addition, you can take the money and pay the taxes on any gains. Normally, you’d also expect to pay a penalty on the earnings but not for scholarships. The penalty is waived on amounts equal to the scholarship, provided they’re withdrawn the same year the scholarship is received, effectively turning your tax-free 529 into a tax-deferred investment. You can always use the money to pay for other qualified education expenses, like room and board, books and supplies. If you are interested in learning more about 529 education plans, please visit our previous posts.

Reference: statecollege.com (Aug. 29, 2021) “Did You Know 529s Are Powerful Estate Planning Tools?”

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benefits of 529 college saving plans

Many Benefits of 529 Plans

There are many benefits of 529 college saving plans. You might think that tax-deferred savings is the main benefit, along with tax-free withdrawals for qualifying higher education expenses. However, there are also state tax incentives, such as tax deductions, credits, grants, or exemption from financial aid consideration from in-state schools in certain states.

Forbes’ recent article entitled “7 Benefits You Didn’t Know About 529 College Savings Plans (But Should)” says there are many more advantages to the college savings programs than simple tax benefits.

1) Registered Apprenticeship Programs Qualify. You can make qualified withdrawals from a 529 plan for registered apprenticeship programs. These programs cover a wide range of areas with an average annual salary for those that complete their apprenticeship of $70,000.

2) International Schools Usually Qualify. More than 400 schools outside of the US are considered to be qualified higher education institutions. You can, therefore, make tax-free withdrawals from a 529 plan for qualifying expenses at those colleges.

3) Gap Year and College Credit Classes for High School. Some gap year programs have partnered with higher education institutions to qualify for funding from 529 accounts. This includes some international and domestic gap year, outdoor education, study-abroad, wilderness survival, sustainable living trades and art programs. Primary school students over 14 can also use 529 funds for college credit classes, where available.

4) Get Your Money Back if Not Going to College. If your beneficiary meets certain criteria, it’s possible to avoid a 10% penalty and changing the plan from tax-free to tax-deferred. For this to happen, the beneficiary must:

  • Receive a tax-free scholarship or grant
  • Attend a US military academy
  • Die or become disabled; or
  • Get assistance through a qualifying employer-assisted college savings program.

Note that 529 plans are technically revocable. Therefore, you can rescind the gift and pull the assets back into the estate of the account owner. However, there are tax consequences, including tax on earnings plus a 10% penalty tax.

5) Private K–12 Tuition Is Qualified. 529 withdrawals can be used for up to $10,000 of tuition expenses at private K–12 schools. However, other expenses, such as computers, supplies, travel and other costs are not qualified.

6) Pay Off Your Student Loans. If you graduate with some money leftover in a 529 account, it can be used for up to $10,000 in certain student loan repayments.

7) Estate Planning. Contributions to a 529 plan are completed gifts to the beneficiary. These can be “superfunded” for up to $75,000 per beneficiary in a single year, effectively using five years’ worth of annual gift tax exemption up front. For retirees with significant RMDs (required minimum distributions) from qualified accounts, such as 401(k)s and traditional IRAs, the 529 plan offers high contribution limits across multiple beneficiaries, while retaining control of the assets during the lifetime of the account owner. Assets also pass by contract upon death, avoiding probate and estate tax.

Work closely with your financial advisor and estate planning attorney to ensure you are getting the most benefits out of your 529 college saving plans.

If you would like to read more about 529 plans, please visit our previous posts.

Reference: Forbes (July 15, 2021) “7 Benefits You Didn’t Know About 529 College Savings Plans (But Should)”

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more pluses than minuses in 529 plans

More Pluses than Minuses in 529 Plans

There are two basic types of 529 plans, says Texas News Today’s recent article entitled “What you need to know about the “529” Education Savings Account.” The more common type is the 529 College Savings Plan. This allows parents, grandparents and others to invest money to cover eligible education for beneficiaries. The less common type is the 529 prepaid tuition program, in which tuition is paid at a set price. Overall, there are more pluses than minuses in a 529 college savings plan. Here is how it works.

Contributions to the 529 Plan aren’t tax deductible at the federal level. However, many states offer state income tax deductions or credits. Your money grows tax-free and withdrawals to pay tuition and other eligible expenses are free of federal taxes and, in many instances, state income taxes.

529 plans can be used to pay for various college fees like tuition, room, food, books, and technology. You can pay up to $10,000 a year for K-12 tuition. You can also transfer the money in your account to other recipients. There are more pluses than minuses in a 529 college savings plan. However, you should note that you may face tax impacts and penalties for withdrawals that aren’t considered eligible costs. Your child’s college needs financial assistance may also be reduced, and you cannot purchase individual stocks within the 529 plan. However, you can select a number of investment options. Even so, you have fewer options than if you were designing your own portfolio.

You can transfer some or all of the existing funds in your account to another investment option twice in a calendar year or after changing beneficiaries. You can also select a different investment option whenever you join the plan. You can switch to another state’s plan once every 12 months. However, there are a few states that exclude such shifts from their plans.

Each state has set a total contribution limit of $235,000 to $542,000 per beneficiary. When an account hits the limit, you will not be able to make any more donations. However, revenue will continue to accumulate. There’s no annual donation limit, but donations are considered gifts for federal tax purposes. Therefore, this year, you could donate $15,000 per donor and per recipient with no federal gift tax. You can also make a $75,000 tax-exempt 529 plan donation and evenly distribute it to your tax return for the next five years, which is an option that some grandparents use as a tool for real estate planning.

The benefits of saving for college through the 529 plan are likely to outweigh the potential impact on financial assistance. Assets in an account owned by either a student or their parents are considered parental assets for federal financial assistance purposes, and typically only 5.64% of accounts are considered annually in the FAFSA (Federal Student Assistance Free Application) calculation. This is an advantage over being counted as a student asset because distribution under this ownership structure doesn’t disqualify the university for financial assistance. The assets of the grandparents’ account don’t impact the student’s FAFSA, but the distribution counts as the student’s income and affects aid.

If you would like to learn more about 529s and other types of investment programs, please visit our previous posts.

Reference: Texas News Today (June 8, 2021) “What you need to know about the “529” Education Savings Account”

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529s are flexible estate planning tools

529s are Flexible Estate Planning Tools

Estate planning attorneys, accountants and CPAs say that 529s are more than good ways to save for college. 529s are flexible estate planning tools, useful far beyond education spending, that cost practically nothing to set up. In the very near future, the role of 529s could expand greatly, according to the article “A Loophole Makes ‘529’ Plans Good Wealth Transfer Tools. Here’s How to Use Them” from Barron’s.

Most tactics to reduce the size of an estate are irrevocable and cannot be undone, but the 529 allows you to change the beneficiaries of a 529 account. Even the owners can be changed multiple times. Here’s how they work, and why they deserve more attention.

The 529 is funded with after tax dollars, and all money taken out of the account, including investment gains, is tax free as long as it is spent on qualified education expenses. That includes tuition, room and board and books. What about money used for non-qualified expenses? Income taxes are due, plus a 10% penalty. Only the original contribution is not taxed, if used for non-qualified expenses.

Most states have their own 529 plans, but you can use a plan from any state. Check to see if there are tax advantages from using your state’s plan and know the details before you open an account and start making contributions.

Each 529 account owner must designate a single beneficiary, but money can be moved between beneficiaries, as long as they are in the same family. You can move money that was in a child’s account into their own child’s account, with no taxes, as long as you don’t hit gift tax exclusion levels.

In most states, you can contribute up to $15,000 per beneficiary to a 529 plan. However, each account owner can also pay up to five years’ worth of contributions without triggering gift taxes. A couple together may contribute up to $150,000 per beneficiary, and they can do it for multiple people.

There are no limits to the number of 529s a person may own. If you’re blessed with ten grandchildren, you can open a 529 account for each one of them.

For one family with eight grandchildren, plus one child in graduate school, contributions were made of $1.35 million to various 529 plans. By doing this, their estate, valued at $13 million, was reduced below the federal tax exclusion limit of $11.7 million per person. This is an example of how 529s are flexible estate planning tools.

Think of the money as a family education endowment. If it’s needed for a crisis, it can be accessed, even though taxes will need to be paid.

To create a 529 for estate planning that will last for multiple generations, provisions need to be made to transfer ownership. Funding 529 plans for grandchildren’s education must be accompanied by designating their parents—the adult children—as successor owners, when the grandparents die or become incapacitated.

The use of 529s has changed over the years. Originally only for college tuition, room and board, today they can be used for private elementary school or high school. They can also be used to take cooking classes, language classes or career training at accredited institutions. Be mindful that some expenses will not qualify—including transportation costs, healthcare and personal expenses.

If you would like to learn more about various estate planning tools, please visit our previous posts. 

Reference: Barron’s (May 29, 2021) “A Loophole Makes ‘529’ Plans Good Wealth Transfer Tools. Here’s How to Use Them”

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Information in our blogs is very general in nature and should not be acted upon without first consulting with an attorney. Please feel free to contact Texas Trust Law to schedule a complimentary consultation.
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