EHDH Estate Planning

How Does Gift Tax Exclusion Work?

How gifts are made could have major impacts on heirs, especially if the recipient is a minor. There are many drawbacks to gifting outright, including limited control over gifts, exposure to creditors, divorce and litigation. Trust options are the recommended strategy, as discussed in the article “The Annual Exclusion For Gift Taxes Has Increased to $16,000—What Issues Should I Consider” from Mondaq.

When gifting directly to minors, a custodial account (ITMA) offers some structure. However, if the account terminates when the minor becomes of age, you then have a young person with no control and a lot of money. This is usually a bad combination.

For example, what if the annual exclusion gift of $16,000 is placed into a custodial account when the heir is nine and ends when the heir celebrates their 18^th birthday? Even if the account earns no interest, by the time the heir reaches age 18, they will have complete access to $160,000 with no restrictions.

If there is a change to the custodian before the minor comes of legal age, the UTMA allows a primary custodian to name a successor. However, if this does not happen, the process of naming a successor custodian is generally burdensome and expensive.

Trust options or a transfer to a 529 plan are better options offering a lot more control by a trustee. Trusts allow assets to be used for a variety of needs, while the 529 plan limits withdrawals to be used for educational needs. The trustee may also continue to manage the account long after the heir has reached legal age, which to most people makes good sense.

Another option is a Section 2503(c) Minors Trust, which can be used for annual exclusion gifts to minors. They require that assets of the trust be applied for the minor who is a beneficiary of the trust. However, there are limited exceptions. There can only be one beneficiary and they must be under age 21. When the beneficiary turns twenty-one, they must be given the ability to withdraw the assets. However, any assets remaining in the trust can be kept in the trust and the trust itself can be converted into another form of irrevocable trust, allowing for continued annual exclusion gifts to be made for the beneficiary.

For more control, consider an irrevocable gift trust. The IGT can be used for the annual exclusion gift and is a smart choice for gifts greater than the annual exclusion when a Gift Tax Return is required. The person creating the irrevocable gifting trust appoints the trustees and should name alternates, if the primary trustee is unable to serve. The trustee then has discretion to manage the assets, including over distributions. Unlike a 2503(c) Minor Trust, the irrevocable gifting trust does not have to terminate or permit unrestricted access to income or principal.

Reference: Mondaq (March 2022) “The Annual Exclusion For Gift Taxes Has Increased to $16,000—What Issues Should I Consider”

Are 529 Plans Part of Your Estate?

Estate planning attorneys, accountants and CPAs say that 529s are more than good ways to save for college. They’re also highly 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 fre,e 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.

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 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.

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

The SECURE Act and Your Retirement

For anyone who has saved a high six- or seven-figure balance in their retirement accounts, the SECURE Act will definitely affect their retirement plans. That includes 401(k)s, 403(b)s, and other workplace plans, as well as traditional IRAs and Roth IRA accounts. The article “How the new Secure Act affects your retirement” from the Daily Camera provides a clear picture of the changes.

Stretch IRAs are Curtailed. Anyone who inherited an IRA (traditional or Roth) from a parent before 2020, may take Required Minimum Distributions (RMDs) from those accounts over their own life expectancy. Let’s say a parent died when you were 48—you could stretch those distributions out over the course of 36 years. This option gave heirs the ability to spread income and the taxes that come with the income out over decades—with little distributions having little impact on taxes. If you inherited a Roth IRA, you could benefit from its tax-free growth over your entire lifetime.

All that’s changed now. A non-spousal heir (or one who is disabled, chronically ill or a minor child) now has ten years in which to take their distributions. They have to pay ordinary income taxes on the amount they take out, over a far shorter period of time. Newly inherited Roth IRAs have the same rules, but usually there are no taxes due. If a minor inherits an IRA, once they reach the age of majority, they have ten years in which to take their distributions.

A Small Break for Required IRA Distributions. Until the SECURE Act, retirees had to start taking their RMDs out of IRAs soon after turning 70½. The new age for taking RMDs is now 72 for those who are younger than age 70½ at the end of 2019. This won’t alter the plans of most retirees, since they usually start taking those distributions well before age 72 to cover expenses. Roth IRAs have another benefit: they continue to escape distribution requirements, unless they are inherited.

No Age Cap for Traditional IRA Contributions. Workers may now continue to contribute funds into a traditional IRA at any age. Before the SECURE Act, workers had to stop contributing funds once they turned 70½. Note that you or your spouse are still required to have earned income to put funds in a traditional or Roth IRA.

Other Changes. There are many more changes from the SECURE Act and thought leaders in the estate planning community will be reviewing and analyzing the law for months, or perhaps years, to come. Some of the changes that are widely recognized already include the ability to withdraw $5,000 penalty-free from retirement plan accounts per newly born or adopted child, although in most cases, income tax will need to be paid on the withdrawal.

Section 529 educational savings accounts can be used, up to a lifetime limit of $10,000 per student, to pay off student loans. In most states, this will be considered a non-qualified withdrawal and state income taxes will be due, but at least the money can be used for this purpose.

Lastly, there are new tax credits available to smaller companies that set up new retirement plans, and there are new rules regarding including part-time employees in company sponsored 401(k) plans.

The changes from the SECURE Act, particularly regarding the loss of the IRA Stretch, have created a need for people to review their estate plans, if they included leaving large retirement accounts to their children. Speak with your estate planning attorney to ensure that your plan still works.

Reference: Daily Camera (Jan. 11, 2020) “How the new Secure Act affects your retirement”

SECURE Act Means It’s Time for an Estate Plan Review

The most significant legislation affecting retirement was signed into law on Friday, Dec. 20, 2019. After stalling for months, Congress suddenly passed several bills, as attachments to budget appropriations, as reported by Advisor News’ article “SECURE Act, Signed by Trump, A Game-Changer For Retirement Plans.”

Here are some of the key points that retirees and those planning their retirements need to know:

Changes to Age Limits for IRA and 401(k) Accounts. The age for taking Required Minimum Distributions (RMDs) has increased from 70½ to 72 years. Adding a year and a half for investors to put away money for retirement gives a little more time to prepare for longer lifespans. The change recognizes the prior limits were arbitrary, and that Americans need to save more.

However, the SECURE Act also brought about the demise of the “stretch” IRA. Americans who inherit an IRA must now withdraw the money within 10 years of the account owner’s death, along with paying taxes. Surviving spouses and minor children are still exempt. The exempt heirs can still spend down inherited IRA accounts over their lifetime, which is an estate planning strategy known as the “stretch.”

Small Business 401(k)s. The SECURE Act expands access to Multiple Employer Plans, known as MEPs, so that employers can pool resources and share the costs of retirement plans for employees. This will cut administration and management costs and ideally, will allow more small businesses to offer higher-quality plans available to their employees.

The law also enhances automatic enrollment and auto-escalation, letting companies automatically enroll employees into a retirement plan at a rate of 6%, instead of 3%. Employers can now raise employee contributions to a maximum of 15% of their annual pay, although workers can opt out of these plans at any time.

Annuities Options. The SECURE Act now allows 401(k) plans to offer annuities as a retirement plan option. Experts have mixed opinions on this. Annuities are a type of life insurance that convert retirement savings into lifetime income. However, fees are often high, and if the insurance company closes its doors, those lifetime income payments may vanish. Under the new law, employers also have what’s called a “safe harbor” from being sued, if annuity providers go out of business or stop making payments to annuity purchasers. Being freed from liability may make employers more likely to offer annuities, but that may put 401(k) investors at more risk, say consumer advocates.

529 Plans and Saving for Children. The new law expands 529 accounts to cover many more types of education, from registered apprenticeships, homeschooling, private elementary, secondary or religious schools. Up to $10,000 can be used for qualified student loan repayments, including for siblings.

Reference: Advisor News (December 23, 2019) “SECURE Act, Signed by Trump, A Game-Changer For Retirement Plans”

How Should I Prepare for My Child’s Future?

It’s been a common path for millennials and their predecessors to go to a four-year college and get a job. If they were short on funds, they’d take out some loans. However, there have been some signals that this norm is changing.

With worries about a student debt crisis and with the experience of recent graduates, new college-age students are increasingly turning to alternatives to the established route to create their own debt-free future.

Kiplinger’s recent article entitled “How to Stay Flexible in Saving for Your Child's Future” says that student debt is leading to obstacles, when it comes to achieving major milestones of financial freedom. Of the young millennials surveyed, nearly half (47%) said they delayed purchasing a home because of  their debt, 40% delayed saving for retirement and 31% waited to move out of their parents’ home. A total of 28% of parents said they delayed saving for their own retirement, to pay for their children’s education.

Saving for a child’s future now looks different than when these 18-year-olds were born.  It certainly will be the case, when they leave the nest. As a result, it’s critical for parents to try to give them help, by learning how to adapt to the changing times.

With the gig economy and digitally enabled side jobs, parents have more flexibility to maintain their financial goals, while preserving their personal lives.

When considering flexibility, especially when saving for a child’s education, it’s actually one of the big benefits of a 529 plan. Although you’re responsible if you make a withdrawal that isn’t for a qualified education expense, the penalties aren’t too steep. Federal income tax is imposed on the plan’s growth, plus a 10% penalty on the growth. Therefore, depending on the amount withdrawn, the penalty may be very little.

Nonetheless, the tax penalties may worry parents enough that even when their goal is to save for their child’s education, they want to spread their savings into multiple accounts. This has some clear advantages, when the child decides not to go to college after high school. The good news is that there are plenty of options to account for both possibilities.

• Other investment accounts: You could also create a brokerage account with money earmarked for a child. This gives parents complete flexibility in how the money is used. The money can be used for expenses other than education, but the downside is not having the tax benefits of the 529 plan (tax deferral and potential tax-free growth).
• Trusts: a trust allows parents to keep complete control over the funds and lets parents provide instructions to the trustee, on how the trust can be used.
• Custodial accounts: These accounts are managed by a guardian (or custodian), until the child is an adult. These accounts are pretty easy to set up but don’t have the restrictions that can be placed on trust funds.

The digital world has changed everything, including how we plan for our children and their future. Be flexible and make your plans accordingly.

Reference: Kiplinger (Dec. 27, 2019) “How to Stay Flexible in Saving for Your Child's Future”

Will Unspent Funds in a 529 Go to Waste?

There are a number of ways to use up those extra funds in a 529 account, according to a recent article from Los Altos Online, “How to use up leftover money in a 529 college savings plan.” The money can be used and you won’t have to worry about the taxes or penalties. Consider these options:

Graduate school. If your child is interested in an advanced degree, the money can be used tax free, just as it was for college. Any school that gets financial aid qualifies.

Another child. You can change the beneficiary of the 529 plan to another qualifying family member, without any tax implications. If you have other children, the funds can be used to pay for their qualified expenses—even if you have other 529 plans for them. Money in 529 plans can now also be used for elementary and secondary education.

Another relative. You can change the beneficiary to parents, aunts, uncles, nieces, nephews, stepparents and even first cousins. There’s no deadline for using the funds, so you can keep it as a gift for a future grandchild. However, avoid skipping a generation, because that could trigger a tax penalty.

Your own or your spouse’s career. If you’re interested in changing your career or just want to get a new degree in retirement, using leftover 529 funds will let you avoid using other savings.

Estate planning. You can choose to give a 529 account to an heir. You keep control of the account until you pass away and can continue to make annual tax-free contributions up to the gift-tax exclusion amount, provided the account value doesn’t exceed the state’s maximum limit. After you die, the value isn’t counted as part of your estate for estate taxes.

Offset any scholarships. You can withdraw any amount from the 529 plan, up to the value of all scholarships and the 10% penalty is waived, even if you apply years after the scholarship was earned. The earnings are taxable, but because distributions include both earnings and contributions, only part of this will be taxed.

Take the hit and spend the money. If there’s no one else who can use the money, you might just pay the taxes and the 10% penalty and use the money, maybe as a security deposit on your child’s first apartment, or to help buy their first car. Remember that earnings are taxed at your child’s rate.

Reference: Los Altos Online (September 18, 2019) “How to use up leftover money in a 529 college savings plan”

Get Your Financial and Legal Life Ready for a New Baby

Preparing for a new addition to the family includes a wide range of lifestyle and financial decisions, says a recent article from Prince William Living, “Baby on the Way? Here’s How You Can Prepare Financially.” These guidelines will get you started, as you begin this new chapter in your family’s life.

Examine your career. A new baby may cause you to think differently about your career goals—you may seek a promotion, a job with a higher salary or better benefits, or more education. Perhaps you or your spouse want to decrease your hours or become a stay-at-home parent. If you are thinking about changing your job status, examine the effect it may have on your take-home pay, retirement nest egg and benefits.

Lifestyle changes. Look at how your baby will affect your day-to-day activities. If your perfect lifestyle involves a new car or home, talk to a financial professional about whether to make the move now or in the future.

Childcare expenses. Nearly one-third of parents spend 20% or more of their income on childcare. In some states, the cost for a year of care can be more than one year of college!

Tuition. Private elementary or secondary school often costs money, and the price of a college education continues to rise at a pace faster than inflation. The 2017 tax reform expanded the use of 529 plans, so you can now withdraw up to $10,000 federal income tax-free per beneficiary, per year to pay for kindergarten through 12th grade tuition at a public, private or religious school.

Review your financial position. Unanticipated events can impact your finances at any time. Resolve to build or maintain an emergency fund that could cover three to six months of expenses. You should also prioritize your retirement savings. After your baby arrives, update your estate plan and insurance coverage as needed.

Consider family values. Consider how you want to teach your child about financial responsibility. Being intentional early, can help create clear expectations and ensure that you and your spouse are on the same page.

The family bucket list. Look at what activities matter to you and add them into your financial plan. Taking an annual vacation or having a vacation home are common goals for many families.

One last and very important thing: a growing family needs an estate plan that includes naming a guardian, should something unexpected happen to you and your spouse. If there is no will, or the will does not include a guardian, the court will decide, under your state’s laws, who should raise your children. An estate planning attorney can help you and your partner make sure that your family is protected.

Reference: Prince William Living (December 2018) “Baby on the Way? Here’s How You Can Prepare Financially”

How is a 529 Plan Treated, If It’s Inherited?

Let’s start by defining a 529 plan. A 529 College Savings Plan is a special type of investment account created pursuant to Section 529 of the Internal Revenue Code and state law. At first, 529 plans were a popular way for families to put away funds for college or other post-secondary educational expenses. The 2017 Tax Act has broadened the plans’ scope to include saving for elementary and high school education.

The question raised in a recent article from nj.com, “Does a 529 plan become part of someone's estate? Is inheritance tax due?” presents an interesting situation.

The short answer is no, 529 plan earnings need not be reported on taxes. These plans are exempt from income tax, if they’re used for qualified education expenses. This includes tuition, fees, books, supplies, equipment, along with room and board at eligible institutions.

Any distributions for anything other than qualified education expenses, will result in the earnings being taxed to the recipient with a 10% penalty.

A contribution to a 529 plan is deemed to be a gift by the contributor to the beneficiary, despite the fact that the custodian on the account can withdraw the funds in the account, subject to tax consequences.

The custodian may also transfer all or some of an account to another beneficiary without tax consequences, but that subsequent designated beneficiary must be a member of the prior beneficiary's extended family, as defined in the Tax Code.

As far as estate taxes are concerned, an interest in a 529 plan typically isn’t included in a decedent's gross estate for federal estate tax purposes.

However, there are some exceptions to this rule, so you’ll want to speak with an estate planning attorney in your state to be sure you are following the law.

In New Jersey, the general rule is that the plan is subject to state inheritance tax, unless the beneficiary is a Class A beneficiary, which includes grandparents, parents, spouses, descendants or stepchildren. Speak with an estate planning attorney to be sure.

Reference: nj.com (October 19, 2018) “Does a 529 plan become part of someone's estate? Is inheritance tax due?”

They’re Not Completely Fool-Proof: 529 College Savings Plans

The new tax law now allows 529 plans to be used for paying for educational expenses from kindergarten to high school to college, says Investopedia in a recent article, “Top 7 Mistakes to Avoid on Your 529 Plan.” Keep in mind that financial professionals are still telling parents that the best use of the funds is for college. Part of that reasoning: the longer period of time that invested funds can grow.

However you use it, there are some things you want to avoid, if you want your 529 investment to pay off when your child is ready to go to school. Here are the top seven mistakes that could cause problems:

1. Failing to First Consider Your State Plan. The number one mistake is picking the wrong plan. When you do your research, begin with your state plan first to see what it offers. Every state offers at least one 529 plan, but they vary. A big benefit with your state plan is that your contributions in more than 30 states can result in a tax credit to lower your annual state tax bill. If you reside in one of five states (Pennsylvania, Arizona, Maine, Kansas or Missouri), you can invest in any state’s plan and still get the tax benefits they offer.
2. Not Understanding Your State’s Guarantee. There are states that provide prepaid tuition plans. However, not all tuition guarantees are identical. Some states offer the chance to lock in tuition fees, provided that your child chooses to go to an in-state school. It is important to use caution, because many states that make this guarantee, don’t guarantee your returns. If your returns fall short, there may not be sufficient funds, even at the guaranteed tuition rate.
3. Failing to Watch Fees and Expenses. Fees and expenses can have a big effect on the success of your investment. Research done by the Financial Research Corporation found that the average annual fee for a 529 plan is 0.69%, if purchased directly from a state. Those 529 plans purchased through brokers average 1.17%. That difference in fees adds up over time.
4. Forking Out Money for Unnecessary Penalties to Switch Plans. If you start out in a 529 plan and realize you’ve made a mistake, you can switch plans. However, use care to avoid penalties and taxes. You are allowed only one penalty-free rollover into a new 529 in any 12-month period. The one exception is if you want to change the family member who’ll benefit from the plan. It’s wise to avoid any risk of penalty or taxes, by working with the new plan administrator to coordinate the transfer. There are other fees in some states, like a recapture tax on past tax deductions, if you do an out-of-state rollover and fees to provide rollover services. Ask about all possible fees, if you are thinking of changing 529 plans.
5. Incorrectly Withdrawing Funds. When you’re ready to start using the funds for your child’s education, be sure you withdraw those funds correctly. The money can only be spent on qualified higher education expenses (QHEE), and if you don’t follow the rules, it can result in taxes and penalties. You should also remember that if you withdraw money before your child enrolls in college, you’ll pay taxes on the money—including an additional 10% penalty on any earnings (not your original deposit). Don't remove the money before your child enrolls. Then just withdraw what’s needed to cover the child's QHEE.

Consider all grants and scholarships when figuring out the amount of money you can withdraw in any one year. You are required to subtract money your child receives from other sources, before taking out 529 funds. If you take out too much, the overage will be deemed taxable income, and you’ll have to pay that additional 10% penalty on the earnings. If your child doesn’t need the money, you’re allowed to transfer the money to another family member without any tax or penalty. You can also save it in the fund for the child's future use, such as graduate school.

6. Non-Qualified Expenses. There are some common college costs that do not qualify as expenses for 529 money, like student loan pay-offs or transportation costs.
7. Waiting to Contribute. The best strategy is to open an account and start funding it shortly after your child is born. You benefit from the longest possible period of time to save, the growth of your investments over time, and the excellent habit of saving on a regular basis. Remember that even if one child doesn’t use the funds, another one can. No need to wait, whether your contributions are large or small.

Reference: Investopedia (May 29, 2018) “Top 7 Mistakes to Avoid on Your 529 Plan”