529 Contributions & Distributions. Advisor Relations Manager June 13, 2014

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1 1 529 Contributions & Distributions Presented by: Vincent Sullivan Advisor Relations Manager June 13, 2014

2 Agenda COLLEGE SAVINGS PLANS: FAMILY DYNAMICS & SITUATIONS Plan Basics Contributions Withdrawals & Distributions Additional Information Questions

3 529 Plan Basics COLLEGE SAVINGS PLANS: FAMILY DYNAMICS & SITUATIONS 3 3 Administered by individual states and maintained by program managers (mutual fund companies). Offers the availability to invest in various investment options (typically age-based and individual fund portfolios) on a tax-advantaged basis. Investment elections may only be changed once per year, per beneficiary. Assets may be used at any accredited higher educational institution which participates in the U.S. Department of Education s Federal Student Financial Aid (FAFSA) program.

4 Who Can Participate COLLEGE SAVINGS PLANS: FAMILY DYNAMICS & SITUATIONS 4 4 Account owners must be U.S. residents & have a Social Security or federal tax ID number. No age restrictions. No income restrictions. Account owner maintains full control of the account, including distributions and investment choices. Beneficiaries may be changed to another family member of the beneficiary at any time without penalty. Accounts may be held without a beneficiary in the case of scholarship accounts or 501c(3) organizations as owners.

5 Contributions COLLEGE SAVINGS PLANS: FAMILY DYNAMICS & SITUATIONS 5 5 Contribution Basics Federal Tax Provisions State Tax Advantages Gift Tax for Multiple Beneficiaries Third-party Contributions

6 Contribution Basics COLLEGE SAVINGS PLANS: FAMILY DYNAMICS & SITUATIONS 6 6 Anyone may make contributions to a beneficiary s 529 plan not just the account owner (frequently the beneficiary s parent). No matter the contribution source, the account owner maintains control. Maximum aggregate contribution and account size limits vary by state, but equal or exceed $235,000 per beneficiary. Colorado limits contributions to accounts after the account values reach $350,000 per beneficiary.

7 General Tax Advantages 7 7 Tax-deferred growth of assets (federal and state) while inside the plan. Tax-free distributions of qualified higher educational expenses (tuition, room and board, books, fees and equipment). Allowance of tax-free rollovers once per 12 months, per beneficiary.

8 Forward Gifting/Estate Tax Benefits 8 8 Five-year forward gifting provision. Up to $70,000 ($140,000 per couple) per beneficiary in a single year, with the special five-year forward gifting provision. Fully gifted amounts inside a 529 are not considered part of an estate. Forward gifted amounts, with the exception of any earnings, will be counted as part of the estate if the contributor passes away within the 5- year timeframe. Example: Grandfather contributes $70,000 ($14,000 x 5 years) in the year 2000 to a grandchild s 529 account. The grandfather passes away in 2003: $14,000 for years 2000, 2001, 2002 and 2003 are excluded from any estate taxation, and $14,000 for year 2004 will be subject to estate taxation. If a beneficiary passes away, the account owner may name another family member of the beneficiary as a new beneficiary without the account becoming part of the estate.

9 COLLEGE Forward SAVINGS PLANS: Gifting FAMILY DYNAMICS Provision & SITUATIONS Example 9 9 Total Contribution Over 10 Years: $200,000

10 State Tax Benefits States and the District of Columbia offer either a deduction or credit on state taxable income for contributions into their plan 4 of those states offer an unlimited deduction from state taxable income (CO, NM, SC & WV) Remember: CO limits contribution when account reaches $350,000 6 additional states are considered tax parity states: Contributions to any state plan are deductible from their state tax income (AZ, KS, MO, MT, PA & ME) States differ on whether the contributor or account owner receive the tax deduction benefit In CO, individuals, estates and trusts generally may take a state income tax deduction for contributions. Transfers or rollovers into a Colorado plan are not eligible.

11 Gift Tax with Multiple Beneficiaries Single parent/account owner contributes to two accounts: Beneficiary for account #1: 17-year-old daughter. Beneficiary for account #2: 12-year-old son. Gift tax contribution limit is $14,000 per child ($28,000 if both parents contribute). Because daughter is closer to college age, parent wants to contribute more to her account. Child #1 receives $20,000. Child #2 receives $8,000. Gift tax implications: Child #1: Amount over $14,000 ($6,000) will be subject to federal gift tax (or forward gifting). Child #2: Entire $8,000 is not subject to gift tax. and

12 Third-Party Contributions, Multiple Beneficiaries Three beneficiaries (siblings): Grandparent contributes $14,000 to each of the three accounts. Parent (account owner) contributes $5,000 to two oldest and $0 to third account. Question: Who receives the state tax benefits and to whom do gift tax provisions apply? Answer: Each contributor (grandparent and parent) for the amounts each has contributed. Question: Can account owner (parent) transfer some/all of grandparent s contributions to another child/beneficiary? Answer: Yes the account owner retains control of the account.

13 Gift Tax After Beneficiary Change Two beneficiaries (siblings), two accounts, owned by their parent: Beneficiary for account #1: 17-year-old granddaughter. Beneficiary for account #2: 12-year-old grandson. Grandparent has contributed the maximum under gift tax rules ($14,000) to each grandchild s account. Question: What happens to gift tax calculation if the beneficiary changes? Answer: IRS has not ruled definitively on this issue yet (see IRS Gift Tax Form 4709). Example: If beneficiary of account #2 is changed to the older child (17-year-old), the contribution to account # 2 has already been made and credited for gift tax purposes to the 12-year-old no current rule requires changing it to the new beneficiary.

14 Other Ways to Contribute Employer direct deposit plans: Free to employer. Encourages regular savings. Same state and federal tax advantages and rules apply. Third-party gifting sites: Family and others can send monetary gifts via websites. Gifts can be directed to a 529 plan through the site. Gifts are made to the individual not directly to a 529 plan: Not eligible for state tax deductions. Gift tax provisions do apply.

15 Withdrawals & Distributions Withdrawal Basics Unused Plan Assets Effect of Tax Credits Effect of Distributions on Financial Aid

16 Qualified Distributions: Definition Distributions made for qualified higher educational expenses are free from federal and state taxes. Qualified distributions include: Tuition Room and board Books Supplies Required equipment (laptops or computers or only considered qualified if they are required by the school) Certain fees

17 Institutions That Qualify Assets may be used at any accredited higher educational institution which participates in the U.S. Department of Education s Federal Student Financial Aid (FAFSA) program, including: Colleges Universities Vocational schools Trade schools Over 500 schools abroad

18 Non-Qualified Distributions Only earnings are taxed upon withdrawal. Taxed as ordinary income at the federal level and subject to an additional 10% IRS tax penalty: Penalty is waived in the case of a scholarship, death, or disability of the beneficiary, or attendance at a military academy. However, earnings are still subject to ordinary income tax. State tax recapture ( clawback ) may apply to principal in an unqualified withdrawal, if a state deduction was taken previously on that money. Rules vary by state. In CO, principal portion of unqualified withdrawals and rollovers from plan are subject to clawback in most cases.

19 Exceptions to 10% Penalty Paid to a beneficiary of the account beneficiary (or to the estate of the designated beneficiary) on or after the death of the designated beneficiary. Withdrawn because the designated beneficiary is disabled. A tax-free scholarship or fellowship. Note: Withdrawal is free from penalty only to the extent the distribution is not more than the scholarship, allowance or payment. Beneficiary attends a U.S. military academy (to the extent that the amount of the distribution does not exceed the costs of education attributable to such attendance).

20 Aggregation: My client s 1099-Q is wrong Aggregation rules indicate: The combined principal and earnings of all identical ownerbeneficiary accounts will determine the breakdown of basis versus earnings for that beneficiary s distributions when the 1099-Q for that calendar year is calculated. This factors into consideration when you have two specific conditions, inclusively: The owner and beneficiary for each of the plans are the same Multiple plans for the same state Let s look at an example, on the next slide.

21 20 Aggregation, example: Two plans: Plan A: $300k contributions, $100k earnings, TMV: $400k Plan B: $50k contributions, $5k earnings, TMV: $55k Distribution request, May 2014, $25k, from Plan B (1099-Q, Box 1) Step 1: Calculate the earnings ratio: $105k/$455k =23% (= %) Step 2: A: Multiply ratio x $25k to get resulting earnings =$5, (Box 2) B: Calculate return of contribution amount: $25k-$5, = $19, basis (Box 3) Step 3: Adjust earnings for EACH plan. Plan B will look like this, for example: a. ($5k/55k)*25k = $2273, actual earnings in plan before distrib. b. Aggregation adjustment: $5,769 - $2,273 = $3,496, representing additional earnings credit and basis debit for this Plan B account. The $30k balance remains the same, but the breakdown of that $30k is adjusted by $3,496.

22 Aggregation, 1099-Q: 22 22

23 Effect of Tax Credits American Opportunity Tax Credit maximum $2,500. Lifetime Learning Credit maximum $2,000. Both are for qualified educational expenses. Credits offset qualified withdrawals from 529 plans. Example: Parent/account owner is receiving maximum $2,500 American Opportunity. Beneficiary/child needs an additional $10,000 from 529 plan for qualified expenses. 529 Plan Qualified Withdrawal $10,000 American Opportunity Tax Credit Taken $2, Withdrawal Not Subject to Federal Income Tax and 10% Penalty $7, Withdrawal Subject to Federal Income Tax and 10% Penalty $2,500 Source:

24 Effect of Distributions on Financial Aid If the account owner is not the beneficiary s parent (e.g., a grandparent). Qualified withdrawals are considered unearned income for beneficiary for purposes of the Free Application for Federal Student Aid (FAFSA) form. Option to avoid reporting distributions as unearned income: Transfer of account ownership to parent prior to taking distribution. Ownership transfers are generally allowed, but rules are plan-specific not all states allow ownership transfers. Ownership transfers are generally irrevocable. CO allows transfers.

25 Additional Information COLLEGE SAVINGS PLANS: FAMILY DYNAMICS & SITUATIONS Sources to Learn More Important Disclosure Questions

26 Resources to Learn More IRS Publication 970 IRS Tax Topics IRS Tax Tips FINRA.org Smart Saving for College Better Buy Degrees

27 Important Disclosure An investor should consider the Program s investment objectives, risks, charges and expenses before investing. The program disclosure statement at scholars-choice.com, which contains more information, should be read carefully before investing. If an investor or an investor s beneficiary is not a Colorado taxpayer, they should consider before investing whether their home states offer 529 Plans that provide state tax and other benefits only available to state taxpayers investing in such plans.

28 Contributions & Withdrawals COLLEGE SAVINGS PLANS: FAMILY DYNAMICS & SITUATIONS Questions?