Funding The Costs Of A College Education

Several tax-advantaged accounts and incentives are now available to help families save for the high cost of education.  The right strategy or combination of programs depends on the family's financial situation and desired goals to be accomplished.


Custodial Accounts
Because minors cannot legally own financial assets or real estate, every state has adopted either the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA) to allow minors to own assets.  Usually, an adult, such as a parent, serves as custodian for the minor and is responsible for prudently managing the child's assets.

Assets gifted to a minor are considered irrevocable and the child has the right to assume control of the assets upon reaching the age of majority (age 18 or 21 depending upon state law).  For a child who has not yet attained age 18 by year-end, the first $850 of unearned income is free of federal tax.  The next $850 is taxed at the child's rate - usually 10%.  However, investment income that exceeds $1,700 is taxed at the parent's highest marginal tax rate.  These figures are adjusted each calendar year.
In general, custodial assets cannot be used for expenses that parents are legally obligated to provide such as food, clothing, shelter and health care.


Coverdell Education Savings Accounts
Anyone may contribute cash into an Education Savings Account (ESA) for the benefit of a minor under 18 years old.  Total annual contributions to a child cannot exceed $2,000 and may be made until April 15th of the year following the contribution year.  Contributions are not tax deductible and must comply with the following tax filing status and adjusted gross income (AGI) limits:


Filing Status

AGI

Contribution

Single

0 to $95,000
$95,001 to $110,000
$110,001+

0 to $2,000 phased out     -0-

Joint

0 to $190,000
$190,001 to $220,000
$220,001+

0 to $2,000 phased out     -0-

All funds within the account grow tax-deferred and may be withdrawn tax-free to pay for school expenses including tuition, room and board, uniforms, fees, and equipment.  Both primary and secondary school expenses qualify.

Distributions that are not used for education expenses are subject to tax and a 10% penalty except if the child dies, becomes disabled, or the distribution is less than or equal to the amount of any tax-free scholarship.  Original contributions are never subject to tax or penalty and are distributed on a pro-rata basis.

ESA funds that are not withdrawn by age 30 of the beneficiary may be transferred to an ESA for the benefit of a sibling.  After age 30, any remaining funds must be withdrawn with earnings subject to income tax and a 10% penalty tax.


Education Tax Credits
A Hope Tax Credit of up to $1,650 per student is available for the first two years of higher education expenses if the student carries at least one-half the normal class load.  The credit is equal to 100% of the first $1,100 of eligible expenses and 50% over $1,100.  Eligible expenses include only tuition and fees.


A Lifetime Learning Credit is available per taxpayer for education expenses equal to 20% of the first $10,000 of tuition and fees for any year of higher education expenses that the Hope Credit is not used.  The Lifetime Credit may be claimed in an unlimited number of years as long as the student carries at least one-half the normal class load.

Both the HOPE and Lifetime Learning Credits are phased out for single filers with an AGI of $47,000 to $57,000 and joint filers with an AGI of $94,000 to $114,000.


Education Expense Deduction
Eligible taxpayers may deduct up to $4,000 from "gross income" for qualifying expenses of tuition and fees.  Eligible taxpayers are single filers with an AGI of less than $65,000 and joint filers with an AGI of less than $130,000.  A deduction of up to $2,000 is available for single filers with an AGI of $65,000 to $80,000 and joint filers with an AGI of $130,000 to $160,000.

Taxpayers cannot claim both this deduction and education tax credits in the same year for the same expenses.

Section 529 Plans
Individuals may contribute up to $12,000 per year ($24,000 for married couples) to a state sponsored higher education savings program on behalf of a designated beneficiary (including himself or herself).

The contributions are considered gifts and grow tax-deferred.  Funds withdrawn for qualified education expenses such as tuition, fees, room and board are free of federal taxes and most states do not tax the earnings.  Some states also allow for a state tax deduction of contributions.

The IRS allows that for contributions in excess of the $12,000 annual gift exclusion, an individual may treat the gift as if it was paid in equal amounts over five years.  Thus, a person may gift up to $60,000 ($120,000 for married couples) in one year without incurring gift taxes as long as no additional gifts are made over the next five years.

Funds may be "rolled over" tax-free from one state program to another state program for the same beneficiary once every 12 months.

If the beneficiary does not utilize the funds, the account may be transferred to a new beneficiary of the same generation within the same family including first cousins to avoid penalties and gift taxes.  Funds not used for higher education may be refunded according to the state's program policy but may be subject to penalties.  Refund penalties are not imposed if the beneficiary dies, becomes disabled, or receives a scholarship of an equal amount.

Contributions to both an Education Savings Account and Section 529 Plan for the same person in the same year are allowed.  However, the total should not exceed $12,000 (annual gift exclusion).  Also, a taxpayer can claim an Education Tax Credit in the same year as receiving a distribution from an Education Savings Account or 529 Plan as long as the credit is not for the same expense as the distribution.


LIFE SETTLEMENTS - SELLING YOUR LIFE INSURANCE POLICY
BEFORE YOU DIE!

  1. A transaction whereby a written agreement is solicited, negotiated, offered, entered into, delivered, or issued for delivery in this state, under which a life settlement provider acquires through assignment, sale, or transfer, a policy insuring the life of an individual who does not have a catastrophic or life-threatening illness or condition by paying the owner or certificate holder compensation or anything of value that is less than the net death benefit of the policy.
  2. The insured is an individual whose life is covered by a life insurance policy.
  3. The owner is the person who has the right to assign, sell, or otherwise transfer a policy, or a certificate issued pursuant to a group policy.  This definition recognizes that, in some instances, the owner and Life Settlor may not be the same person under the policy.
  4. The insured may be different than the owner of the policy, although they are often the same person.  If the policy is owned by a different person or entity (like a life insurance trust), both the insured and the owner must consent to the transaction and both must sign the contract.
  5. The Life Settlor is an individual who is the insured and enters into a life settlement contract or presents a policy for consideration to a broker or provider.
  6. The Life Settlement Provider is the company which buys the policy in a life settlement.
  7. The Life Settlement Broker is a person who for compensation represents the Life Settler, or owner in negotiations for the best offer on a policy.  The broker does not buy the policy and does not work for the provider.  The broker works only on behalf of the seller and owes a fiduciary duty to the Life Settlor or owner.  A good broker is familiar with current market conditions and various providers in the market as well as what information those providers will require.  Generally, the broker will gather this information and transmit it to various providers on behalf of the Life Settlor.
  8. A provider is the purchaser of the policy while a broker is the representative of the Life Settlor or owner.  The broker presents the policy to one or more providers and may offer market advice to the seller of the policy.  The broker's goal should be getting the best deal for the seller.  This includes negotiating on behalf of the seller, giving general market advice such as how marketable the policy is and the reputation of various providers in the industry, fairly presenting the policy to providers, transmitting all offers to the seller and helping the seller make an informed decision.  Because providers and brokers perform very different roles in the transaction, you will want to ask whether the company you are dealing with is a provider or a broker.
  9. Selling your life insurance policy may allow you to:
    • Enjoy a higher quality of life
    • Enjoy personal independence and dignity
    • Purchase financial products or investments which are more suited to your present life circumstances.
    • Exercise greater control over your health care options
    • Take care of any personal debt
    • Take a dream vacation
    • Buy a new car or home
    • Make gifts to loved ones or charities
    • Compensate for lost income
    • Take care of financial arrangements
    • Have peace of mind
  10. The amount you may receive on an offer for a policy is affected by a number of factors such as your life expectancy, future premiums due on the policy, whether or not there is a loan on the policy, and the market conditions for your policy.
  11. Most individual and group life insurance policies with a face value of $100,000 or greater can be sold.  The policy must not contain a restriction prohibiting transfer of ownership rights and all parties must agree to the transfer of ownership.<
  12. The Life Settlement Provider who buys the rights to your policy is responsible for the payment of the premiums after you sell your policy.
  13. The entire process usually takes between 3 and 6 weeks, depending on the amount of cooperation from your health care providers and your life insurance company.
  14. The Life Settlement Provider charges no fees to you, but the Life Settlement Broker gets compensated by the Life Settlement Provider.
  15. In most circumstances, the money you receive from the sale of your policy will be subject to federal income tax and state income tax.  In addition, federal law requires that the escrow agent send an IRS Form 1099 to the owner of the policy and the IRS.  This cannot be avoided by directing that the proceeds be paid to another party.
  16. The policy must be issued by a US insurer or a foreign insurer which does business in the US and is subject to US laws.  If the insured is a resident alien with a US social security number, the insured may be able to sell the policy.

TIME TO REVIEW YOUR BENEFICIARY DESIGNATIONS FOR IRAS

It is extremely important to make sure that your beneficiaries are properly designated for your IRAs and other retirement accounts, since the beneficiary designation controls the disposition of the retirement account at your death, regardless of what your Will, Trust, divorce settlement, or any other agreement stipulates.

The following advice is based on a presentation given by IRA expert, Ed Slott:

  1. Obtain a copy of the beneficiary form for each IRA you own.
  2. Make sure you have named a primary beneficiary and a secondary (contingent) beneficiary for each IRA you own.
  3. If there are multiple beneficiaries on one IRA, make sure that each beneficiary's share is clearly identified with a fraction, percentage or the word "equally," if applicable.
  4. Make sure that the financial institution holding the IRA has your beneficiary designations on file and that their records agree with your records.
  5. Keep a copy of all your IRA beneficiary forms and give copies to your financial advisor, attorney, and CPA.
  6. Let your beneficiaries know where to locate your IRA beneficiary forms.
  7. Review your IRA beneficiary forms at least once a year to make sure they are correct and reflect any changes during the year due to new tax laws or major life events such as death, birth, adoption, marriage, divorce, etc.
  8. Check the IRA custodial document for every financial institution that holds an IRA account for you.  Make sure that the document allows the provisions that are important to you and your beneficiaries.
  9. Do not name your estate as beneficiary of your retirement account as it will cause adverse income tax consequences as well as subject it to creditors' claims.
  10. Consider a separate IRA Trust to obtain maximum stretch-out and protection of your IRAs for younger beneficiaries.

LEAVING AN INHERITANCE TO A DISABLED CHILD VIA A SUPPLEMENTAL OR SPECIAL NEEDS TRUST IS THE BEST OPTION

  1. In almost all cases where a parent wants to leave funds at death to a child with special needs, this should be done in the form of a trust.  Trusts set up for the care of a child with special needs generally are called "supplemental" or "special" needs trusts.
    Money should not go outright to the child, both because the disabled child may not be able to manage it properly and because receiving the funds directly may cause the child to lose public benefits, such as Supplemental Security Income (SSI) and Medicaid.  Often, these programs also serve as the entry point for receiving vital community support services.  In the case of SSI, at the end of 1999 Congress enacted laws making it must more difficult to create a trust for a disabled individual after she has received an inheritance, making it even more important that the parents create the trust as part of their estate plan.
  2. Special needs trusts (also known as "supplemental needs" trusts) allow a disabled beneficiary to receive gifts, lawsuit settlements, or other funds and yet not lose his or her eligibility for certain government programs.  Such trusts are drafted so that the funds will not be considered to belong to the beneficiary in determining eligibility for public benefits.
    Special needs trusts are designated not to provide basic support, but instead to pay for comforts and luxuries that could not be paid for by public assistance funds.  These trusts typically pay for things like education, recreation, counseling, and medical attention beyond the simple necessities of life.  (However, the trustee can use trust funds for food, clothing, and shelter if the trustee decides doing so is in the beneficiary's best interest despite a possible loss or reduction in public assistance).  Special needs can include medical and dental expenses, annual independent check-ups, necessary or desirable equipment (such a specially equipped vans), training and education, insurance, transportation, and essential dietary needs.  If the trust is sufficiently funded, the disabled person can also receive spending money, electronic equipment and appliances, computers, vacations, movies, payments for a companion, and other self-esteem and quality-of-life enhancing expenses.
    Often, special needs trusts are created by a parent or other family member for a child with special needs (even though the child may be an adult by the time the trust is created or funded).  Such trusts also may be set up in a Will as a way for an individual to leave assets to a disabled relative.  In addition, the disabled child can often create the trust himself, depending on the program for which the disabled child seeks benefits.  These "self-settled" trusts are frequently established by individuals who become disabled as the result of an accident or medical malpractice and later receive the proceeds of a personal injury award or settlement.
  3. A parent with a child with special needs may consider buying life insurance to help fund the special needs trust set up for the child's support.  What may look like a substantial sum to leave in trust today may run out after several years of paying for care that the parent had previously provided.  The more resources available, the better the support that can be provided to the disabled child.  And if both parents are alive, the cost of "second-to-die" insurance -- payable only when the second of the two parents passes away - is very cost effective.
  4. Each public benefits program has restrictions that the special needs trust must comply with in order not to jeopardize the beneficiary's continued eligibility for public benefits.  Both Medicaid and SSI are quite restrictive, making it difficult for a beneficiary to create a trust for his or her own benefit and still retain eligibility for Medicaid benefits.  But both programs allow two "safe harbors" permitting the creation of special needs trusts with a beneficiary's own money if the trust meets certain requirements.
    The first of these is called a "payback" or "(d)(4)(A)" trust, referring to the authorizing statute.  "Payback" trusts are created with the assets of a disabled individual under age 65 and are established by his or her parent, grandparent or legal guardian or by a court.  They also must provide that at the beneficiary's death any remaining trust funds will first be used to reimburse the state for Medicaid paid on the beneficiary's behalf.
    Medicaid and SSI law also permits "(d)(4)(C)" or "pooled trusts."  Such trusts pool the resources of many disabled beneficiaries, and those resources are managed by a non-profit association.  Unlike individual special need trusts, which may be created only for those under age 65, pooled trusts may be for beneficiaries of any age and may be created by the beneficiary.  In addition, at the beneficiary's death the state does not have to be repaid for its Medicaid expenses on his or her behalf as long as the funds are retained in the trust for the benefit of other disabled beneficiaries based upon the federal law; however, some states require reimbursement under all circumstances.  Although a pooled trust is an option for a disabled individual over age 65 who is receiving Medicaid or SSI, those over age 65 who make transfers to the trust will incur a transfer penalty.
  5. Income paid from a special needs trust to a beneficiary will reduce SSI benefits by one dollar for every dollar paid to him or her directly.  In addition, payments by the trust to the beneficiary for food or housing are considered "in kind" income and, again, the SSI benefit will be cut by one dollar for every dollar of value of such "in kind" income.  You can draft the trust to limit the trustee's discretion to make such payments or draft the trust in a way which does not limit the trustee's discretion, but instead advises the trustee on how the trust funds may be spent, permitting more flexibility for unforeseen events or changes in circumstances in the future.  Each case will be different based on the client's situation and the amount of money in the trust.
  6. Choosing a trustee is one of the most important and difficult issues in special needs trusts.  The trustee must have the necessary expertise to manage the trust, including making proper investments, paying bills, keeping accounts, and preparing tax returns.  A professional trustee will have these skills, but may be unfamiliar with the beneficiary and his or her unique needs.  It is possible to simultaneously appoint both a professional trustee and a family member to serve as co-trustees.  It's also possible to hire a trust "protector", who has the power to review accounts and to hire and fire trustees, and a trust "advisor", who instructs the trustee on the beneficiary's needs.  However, if the trust fund is small, a professional trustee may not be economically feasible.  Make sure that the trustee you choose is financially savvy and trustworthy, and will serve the best interests of the disabled child.
  7. Many disabled people rely on SSI, Medicaid or other government benefits to provide food and shelter.  You may have been advised to disinherit your disabled child with special needs - the child who needs your help most - to protect that child's public benefits and give such share of your estate to the siblings of the disabled child with the hope that your other healthy children will provide for their disabled sibling.  But SSI and Medicaid benefits rarely provide more than subsistence.  And this solution does not ensure that your disabled child after you are incapacitated or deceased will be financially protected.  When your disabled child requires or is likely to require governmental assistance to meet their basic needs, you must and should consider establishing a special needs trust.
  8. Finally, one key benefit of creating an inter vivos or lifetime special needs trust is that your extended family and friends can also make lifetime gifts to the trust or include the trust in their estate planning upon their death.  You or your extended family members can also consider whether making the trust the beneficiary of a life insurance policy while such person is healthy and insurance rates are low.  In these cases, the special needs trust should be irrevocable rather than revocable to exclude the life insurance proceeds from being subject to federal and/or state estate taxes.