Introduction/Legal Note

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1 Sponsored by Wealth Management Strategies: 529 Plans How To Maximize i Their Hidden Value in 2014 Presented by: Chris Stack, Esq. Managing g Consultant This presentation may not be reproduced or distributed for any purpose without the express written consent of Savingforcollege.com LLC. All rights reserved. Your clients should consider the investment objectives, risks, charges, and expenses of any 529 Plan Investment Options carefully before investing. This and other information is contained in the 529 Plan disclosure Document, which should be read carefully. Before investing, your clients should read the Plan Disclosure Statement carefully and consider whether their state of residency or their intended Designated Beneficiary s state of residency offers any benefit, such as a state tax deduction, which is only available for investments in that state s 529 savings program. Investment Products: Not FDIC Insured / May Lose Value / Not Bank Guaranteed Introduction/Legal Note SFC is a well known independent resource and authority on 529 plans. Chris Stack has been a member of the NYS Bar for over 20 years and leads SFC educational and training efforts. He has served as author of 529 state legislation for several states and is very familiar with relevant provisions of Section 529 and various state programs and opened two 529 accounts in SFC and its affiliates are not broker-dealers, not affiliated with American Century or any product sponsor or broker-dealer of its affiliates and are not in the business of selling or offering securities and do not make recommendations to buy or sell securities of any kind. We do, however, receive fees from many managers of these programs, for a variety of products and services that we furnish, including a fee from American Century for speaking before you today and others other times. IRS Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, you are informed that any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding U.S. tax penalties. This presentation does not constitute tax advice and investors should consult their tax advisors prior to making contributions to a 529 plan. 1

2 Most Clients Have the Same 2 Long-Term Financial Goals 1. Safe & secure retirement 2. Education of family members Why Should Every Advisor Promote College Savings & Investing? Client Need Their Help The client s (grand)kids are 1 year closer to college years College costs continue to rise 2x CPI Meaningful financial aid is NOT available for most clients Most financial aid consists of loans; increasing the cost Numerous Benefits are Available beyond a college account = Need to Plan and Prepare Clients! 2

3 College Costs are High Now and Still 2x CPI: Cost of attendance x 4 years x 4 years = Cost not < Baylor $54,086 $216,344 University of Chicago $63,860 $255,540 University of Florida (non-res) $42,498 $169,992 George Washington (DC) $62,618 $250,472 Notre Dame $60,117 $240,468 NYU $64,047 $256,188 Rice $54,291 $217, SMU $61,767 $247,068 TCU $50,530 $202,120 UT Austin $27,096 $108,384 U So. Cal $62,245 $248,980 Two basic forms of financial aid: What about Financial Aid? Merit aid to induce an exceptional student to attend a particular college or university mostly funded by a college Needs-based aid based upon the difference between the college cost and the federal formula s determination of the family s ability to pay; Most aid = loans The 2013 graduate had an average of > $35,000 of loans 1 1 Fidelity Broker/Dealer or CPA Use Only Distribution 2014 to Savingforcollege.com any Other Audience is LLC Prohibited 2013 Savingforcollege.com LLC 3

4 What about 529 Accounts and Financial Aid? 529 accounts are treated as assets of the account owner, thus Who is the 529 account owner? Grandparent Zero impact Parent eligible asset = 5.6% counted Student/UGMA none 529 investment: 20% of assets Student owning a 529 acct through UGMA = 5.6% = No penalty for owning a 529; treatment is no different than many/most other assets Broker/Dealer or CPA Use Only Distribution 2014 to Savingforcollege.com any Other Audience is LLC Prohibited 2013 Savingforcollege.com LLC Why Should We Use 529 Plans? The Best Way To Save for College : SFC 2nd leading reason for long term saving/investing = STICKY ASSETS One of the biggest obstacles to the preservation and growth of individual and family wealth over time is: Inflation Improper asset allocation/bear markets Taxes! 4

5 Taxes have risen: 2013 rates Why Are 529 Plans the Solution? I. 529 accounts grow free of federal and state taxes II. III. IV. Qualified withdrawals free of federal and state taxes (except AL) Most college and graduate school expenses are qualified No age, time, or income limit on owner/account V. No residency requirement VI. VII. No penalty for financial aid awards Generous gift and unique estate tax treatment VIII. Federal/state creditor protection may be available (Title 5 TX Property Code) IX. Beneficiary never has any access to account X. Owner always has daily liquidity and control Clients must be informed that depending upon the laws of their home state, favorable state tax treatment of funding a Section 529 plan may be limited 2014 Savingforcollege.com to investments made LLC into plan offered by their home state. 5

6 Federal Income Tax Rules Qualified withdrawals: 2 prong test 1. What type of school? See: 2. What type of expense: Tuition, fees, room & board, books, supplies & equipment required for attendance no transportation & no beer $ Federal Income Tax Rules Qualified withdrawals from a 529 plan are excluded from federal income taxes: Hypothetical Example: If $100,000 is contributed today for an 11-year old Assume growth over 7 6% to $150,000 = $50,000 of earnings is excluded from federal and 49 states income taxes (if any) when withdrawn for qualified expenses! The hypothetical return does not represent the return of any particular investment. 6

7 What Happens if Not Used for College? If owner decides not to use for designated beneficiary s college expenses, they have three options: 1. Change beneficiary to member of beneficiary s family 2. Do nothing and continue to earn on tax-deferred basis 3. Withdraw funds for any other purpose and pay taxes and penalty on earnings withdrawn Federal Law: Non-Qualified Withdrawals Redemptions/Withdrawals are pro-rata rata principal and earnings Basis/value of account x distribution = principal p portion Earnings portion taxed to distributee (account owner or beneficiary at his/her lower tax rate) ) as ordinary income* Federal penalty (10% of the earnings portion only) Penalty exceptions for beneficiary s death, disability, receipt of a scholarship or use of other tax credits for expenses NO Net Investment Income Tax *Non-qualified withdrawals payable to the account owner may result in return of funds to owner s taxable estate. 7

8 Federal Income Tax Rules Non-Qualified withdrawal of earnings are taxable to distributee at ordinary federal tax rates plus 10% penalty - Hypothetical Example: $100,000 grows to $150,000 over 7 6% A $30,000 withdrawal for non-qualified expenses only = 100/150K x 30 = $20,000 ROP = no tax $10,000 10% tax rate = $1,000 $10,000 earnings x 10% penalty = $1,000 Total federal tax and penalty = $2,000 NO NIIT ON ANY WITHDRAWAL!! Federal Income Tax Rules Non-Qualified withdrawal requires tax on earnings plus a 10% penalty IF: : $100,000 achieves no growth or earnings; remains flat A $30,000 withdrawal for non-qualified expenses only = 100/100k x 30 = $30, return on principal = No federal tax or penalty due 8

9 What About Gift and Estate Taxes? What Are the Potential Gift/Estate Tax Benefits? What Are the Potential Gift/Estate Tax Benefits? Contributions to a 529 account are completed gifts to designated beneficiary The annual $14,000 gift tax exclusion applies to funding One may elect to apply five years worth of annual exclusions (up to 70,000 for single filers; $140K joint) at once* (use Form 709) New Unified/Lifetime Gift Tax Credits per person are also available ($5.34M) Some states have their own estate tax (including CT, NJ, NY, MA, WA) Funding = Gifting removes the asset from the donor s taxable estate *The Donor must be alive on January 1 of the year for which they claim such annual exclusion or that portion of the contribution must be added back to the Donor s estate for determining the taxable estates. 9

10 An Example: Maximizing the Value of a 529 Account John and dhis wife compare funding four 529 accounts naming each of four grandchildren, versus funding a taxable account in 2012: With 529 Accounts Without 529 accounts $100,000 x 4 accounts x $400,000 x 4.2% (6% x 6% x 7 years (no annual taxes) - 30%*) x 7 years = $601,452 = $533,500 +$67,952 * Illustration is only hypothetical & does not represent the return of any specific investment return. Reflects potential-in in state & federal tax rates. Lower maximum tax rates on capital gains and dividends would make the investment return for the taxable investment more favorable, thereby reducing the difference in performance between the accounts shown and higher tax rates would likewise increase the difference. Maximizing the Value of a 529 Account If they did invest in 2013 and died 7 years later in 2020, their heirs (not 529 beneficiaries) inherit either: With 529 Accounts Without 529 accounts $601,452 (full account) $320,100 after 40% federal & state with no estate taxes due estate tax* of $213,400 = $281,352 more after 7 years on original $400,000 having invested in the four accounts (assumes estate tax credits applied to other assets in taxable estate) * Hypothetical tax rate based on maximum federal estate tax of 40% as of

11 An example: Maximizing the Value of a 529 Account Even if the estate tax is eliminated or modified with no application to them, then they still: Have >$68K more after 7 years due to income tax deferral Continued to own and control those assets in 529 account Transfer 529 accounts to successor owner with no probate How May a Trust Benefit? Many trusts are set up to fund educational expenses Trusts are subject to high federal and state income tax rates 39.6% + 3.8% federal tax rate on earnings > $12,150; + some state rates > 9% Trusts may invest in and own a tax-free 529 account(s) Irrevocable trusts may max funding an account for each beneficiary Trusts may take qualified withdrawals or carve out new accounts 11

12 What About UGMAs? UGMAs have lost their tax advantage they once enjoyed Tax rates for incomes > $2,000 at parent s rate up to age 18 Now,, taxed at parent s rate up to age 24 for full-time students 1 Solution: Invest UGMA (cash) in a 529 plan 2 Tax on earnings = 0% rather than parent s rate Already gifted: not subject to annual gifting amount 1 Applies only to children whose earned income is not > one-half of the amount of their support. 2 UGMAs are irrevocable and one cannot change UGMA beneficiary. 529 plans may only accept cash. In order to invest assets from an UGMA account into a 529 plan, the account owner may have to sell assets in the UGMA account, pay taxes on those assets, and then transfer the money to the 529 plan. Whereas the tax advantages of 529 plan earnings attach to withdrawals for higher education expenses, expenditures from an UGMA account may be less restricted. Funding the 529 Account A $4,000 investment? -or a - $400,000 investment? 12

13 Why Would A Client Not Choose to Fund the 529 Account? The client requires all invested assets for income They have all of their assets in qualified plans They believe they can net a higher return elsewhere The client does not care for their child or grandchild They don t understand that they always maintain complete control over the account and they are unaware that the penalty is 10% on earnings withdrawn pro- rata not the full withdrawal! Managing the 529 Account Accounts are typically tapped before retirement account There is a need to access funds in shorter time span = less time to recover losses/underperformance Investment reallocation is restricted Investment changes to account only 1x per year Rollovers - similar to IRAs New plan transfers no cost, penalty or taxes if within 60 days or Trustee to Trustee Rollovers are not included in annual change limit 13

14 Selecting a 529 Plan Are you familiar with the underlying funds? Are there multiple investment choices? How is the age-based portfolio structured? Are there forms required to adjust account or withdraw? Are there hidden fees/restrictions? Is there investment flexibility? What is the plan s net performance? What is the cost/value trade-off? The views expressed in this material are the views of Savingforcollege.com and are subject to change without notice at any time based upon market and other factors. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. This information may contain certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those discussed. There is no guarantee that investment objectives will be achieved or that any particular investment will be profitable. Past performance does not guarantee future results. 14