News
Tax
Feb. 15, 2002
Financial Aid
Dicta Column - By Ralph Bovitz - Under new federal tax rules, saving for college just got a bit easier and more practical for attorneys wishing to plan for their children's higher education. Attorneys now can save and pay for their children to attend any college or approved vocational school and receive some tax breaks in the process.
Dicta Column
By Ralph Bovitz
Under new federal tax rules, saving for college just got a bit easier and more practical for attorneys wishing to plan for their children's higher education. Attorneys now can save and pay for their children to attend any college or approved vocational school and receive some tax breaks in the process.
Unlike the past, you no longer have to decide in advance which college your child ultimately will attend when he or she is still an infant. Family members who establish a college savings plan under the new federal tax rules can accumulate funds tax-deferred and ultimately spend them tax-free, and the child can attend whatever school for which he or she is qualified. This was made possible by improvements to a college education funding provision in Internal Revenue Code Section 529. Plans established under this provision are now commonly referred to as Section 529 plans.
Before this change was made to the code, gifts of money could incur a tax liability. For instance, gifts of more than $11,000, such as from a grandparent who wishes to help with college education, in any one year could have triggered a gift tax. The grandparents can now set up a Section 529 plan for a child, with a gift of up to $55,000 in the first year, and incur no gift tax consequences.
For a Section 529 plan, the contribution is considered a gift made over a 5-year period. Should the grandparent die before the five years has elapsed, however, a pro rata portion of the gift is brought back into the grandparent's estate. To set aside more than $55,000 for an individual grandchild, each grandparent may setup a separate Section 529 plan. Plans must be established before the child is 18 and the child must use all funds accumulated for qualified education purposes by age 30.
Creating a Section 529 plan is not limited to grandparents. Parents, aunts and uncles also can contribute to a Section 529 plan.
Hopefully, the Section 529 plan assets will grow to meet the education costs when needed. However, the Section 529 plan does not guarantee a specific fund balance when it's time for college. In fact, losses to original principal may occur or only modest growth may result. For a guaranteed amount, family members may purchase shares in a prepaid tuition plan. However, such plans generally limit expenditures to tuition and fees. And although such plans may be used for out-of-state or private schools, the prepaid plans may not meet the costs at those schools.
Section 529 plan assets are invested by money managers who adhere to an investment program that becomes more conservative as the child gets closer to college age. The family member who sets up the Section 529 plan cannot manage the account or otherwise direct its investments. However, the family member can move the account to another Section 529 plan, under certain circumstances, once a year or if the plan is assigned to a different child.
When the funds are used for qualified education costs, there is no tax on the money withdrawn from the plans. Qualified education costs eligible for Section 529 plan funds have been broadened from meeting just tuition and fees to include room and board, books, supplies and equipment.
Another tax feature that should appeal to lawyers is that, if the assets are removed from the plan, the plan can reclaim the funds at any time. This becomes important if the family member, for example, encounters financial difficulties and needs the funds. The only forfeiture is a tax on growth plus a 10 percent penalty.
Moreover, the family members who set up the Section 529 plan are not required to give any reason for reclaiming its assets. Thus, the child can be denied access to the plan assets if he or she tries to use the money for a new car instead of college. The plan's assets are under the control of the family member and do not have to be made known to the child.
There are nearly 40 states, including California, offering Section 529 plans and approximately 18 money management firms directing the investment of plan assets in those states. The money managers include well-known mutual funds and brokerage houses. An attorney or attorney's family member can participate in a plan located in Iowa and use the funds accumulated to pay for college in California.
While it is now easier to save for college, care needs to be taken in selecting the plan that will meet your needs now and in the future. There are no uniform rules governing the Section 529 plans beyond the rules to realize tax benefits. Thus, you'll want to inquire about the plan manager's beneficiary restrictions, minimum and maximum contributions, how easily the funds can be rolled into another plan or to another beneficiary, state tax treatment and refund policies. If one plan appears negative in one category, look into another plan because the funds can be used to fund a college education in any state regardless of which state's Section 529 plan is selected.
Ralph Bovitz, a certified public accountant in Woodland Hills, is chair of the personal financial planning committee of the California CPA Society's Los Angeles Chapter.
By Ralph Bovitz
Under new federal tax rules, saving for college just got a bit easier and more practical for attorneys wishing to plan for their children's higher education. Attorneys now can save and pay for their children to attend any college or approved vocational school and receive some tax breaks in the process.
Unlike the past, you no longer have to decide in advance which college your child ultimately will attend when he or she is still an infant. Family members who establish a college savings plan under the new federal tax rules can accumulate funds tax-deferred and ultimately spend them tax-free, and the child can attend whatever school for which he or she is qualified. This was made possible by improvements to a college education funding provision in Internal Revenue Code Section 529. Plans established under this provision are now commonly referred to as Section 529 plans.
Before this change was made to the code, gifts of money could incur a tax liability. For instance, gifts of more than $11,000, such as from a grandparent who wishes to help with college education, in any one year could have triggered a gift tax. The grandparents can now set up a Section 529 plan for a child, with a gift of up to $55,000 in the first year, and incur no gift tax consequences.
For a Section 529 plan, the contribution is considered a gift made over a 5-year period. Should the grandparent die before the five years has elapsed, however, a pro rata portion of the gift is brought back into the grandparent's estate. To set aside more than $55,000 for an individual grandchild, each grandparent may setup a separate Section 529 plan. Plans must be established before the child is 18 and the child must use all funds accumulated for qualified education purposes by age 30.
Creating a Section 529 plan is not limited to grandparents. Parents, aunts and uncles also can contribute to a Section 529 plan.
Hopefully, the Section 529 plan assets will grow to meet the education costs when needed. However, the Section 529 plan does not guarantee a specific fund balance when it's time for college. In fact, losses to original principal may occur or only modest growth may result. For a guaranteed amount, family members may purchase shares in a prepaid tuition plan. However, such plans generally limit expenditures to tuition and fees. And although such plans may be used for out-of-state or private schools, the prepaid plans may not meet the costs at those schools.
Section 529 plan assets are invested by money managers who adhere to an investment program that becomes more conservative as the child gets closer to college age. The family member who sets up the Section 529 plan cannot manage the account or otherwise direct its investments. However, the family member can move the account to another Section 529 plan, under certain circumstances, once a year or if the plan is assigned to a different child.
When the funds are used for qualified education costs, there is no tax on the money withdrawn from the plans. Qualified education costs eligible for Section 529 plan funds have been broadened from meeting just tuition and fees to include room and board, books, supplies and equipment.
Another tax feature that should appeal to lawyers is that, if the assets are removed from the plan, the plan can reclaim the funds at any time. This becomes important if the family member, for example, encounters financial difficulties and needs the funds. The only forfeiture is a tax on growth plus a 10 percent penalty.
Moreover, the family members who set up the Section 529 plan are not required to give any reason for reclaiming its assets. Thus, the child can be denied access to the plan assets if he or she tries to use the money for a new car instead of college. The plan's assets are under the control of the family member and do not have to be made known to the child.
There are nearly 40 states, including California, offering Section 529 plans and approximately 18 money management firms directing the investment of plan assets in those states. The money managers include well-known mutual funds and brokerage houses. An attorney or attorney's family member can participate in a plan located in Iowa and use the funds accumulated to pay for college in California.
While it is now easier to save for college, care needs to be taken in selecting the plan that will meet your needs now and in the future. There are no uniform rules governing the Section 529 plans beyond the rules to realize tax benefits. Thus, you'll want to inquire about the plan manager's beneficiary restrictions, minimum and maximum contributions, how easily the funds can be rolled into another plan or to another beneficiary, state tax treatment and refund policies. If one plan appears negative in one category, look into another plan because the funds can be used to fund a college education in any state regardless of which state's Section 529 plan is selected.
Ralph Bovitz, a certified public accountant in Woodland Hills, is chair of the personal financial planning committee of the California CPA Society's Los Angeles Chapter.
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