Coverdell, Custodial Account or 529?
How to Choose
Protecting Your Assets
in Litigious Times
When Moving IRA Money, Take the Direct Approach
Taxes: An Expense Most Retirees Didn't See Coming
Coverdell, Custodial Account or 529?
How to Choose
First, the bad news: The cost of a college education continues to climb at rates well above the
general inflation rate. Now, the good news: Your options for setting aside college money in
tax-efficient investment accounts continue to improve. Three vehicles well worth investigating
are 529 plans, Coverdell Education Savings and custodial (UGMA/UTMA) accounts.
The Lowdown on 529 Plans
529 plans are generally sponsored by individual
states, but in some cases may also be sponsored
by qualified educational institutions.1 They are
administered by investment companies, which
also oversee the underlying investments.
There are two types of 529 plans:
Prepaid tuition plans let participants pay
for future tuition at today's rates, essentially
taking inflation out of the equation.
529 college savings plans—the focus of this
discussion—let you invest your contributions
in managed financial instruments. 529 college
savings plans have grown increasingly popular
due to their tax advantages and flexibility.
While each state plan differs, all 529
college savings plans allow you to invest
contributions in some type of professionally
Potential benefits include tax-free withdrawals
for qualified expenses; higher contribution
limits than other types of college accounts;
gift tax benefits for contributors; the option
of lump-sum or systematic contributions; the
ability to control assets and beneficiaries; and
professional asset management. In addition,
there are similar risks to other investments,
with the level of risk varying depending
on exactly which investments you choose
within a 529 plan.
UGMA/UTMA Accounts: Awarding Custody
Not all college savings strategies require the
involvement of a college or a state government.
For example, under the Uniform Gifts to
Minors Act (UGMA) or Uniform Transfers
to Minors Act (UTMA)—each state uses
one or the other—adults such as parents
and grandparents can establish and contribute
to a custodial account in a minor's name
without having to establish a trust or name
a legal guardian.
Contributing to an UGMA/UTMA account can
accomplish two important objectives: helping a
future student pay for college and reducing the
value of a contributor's taxable estate. There
are no income limits affecting eligibility to
fund a custodial account, and individuals can
contribute up to the maximum gifting limit of
$14,000 per beneficiary, per year ($28,000 for
married couples). Beyond those amounts, they
may be subject to federal gift taxes.
Gifts made to UGMA/UTMA accounts are
considered irrevocable; once the child reaches
legal age, he or she gains full control over
the assets. Since custodial accounts belong
to the child, account assets may decrease the
amount of financial aid a child can receive.
Rapidly changing tax rules affecting UGMA/UTMA accounts bear careful consideration. Under the so-called "Kiddie Tax" rules, a child's investment income over a certain level is taxed at their parents' rate rather than the child's lower rate (typically 5% for most children). Prior to 2006, the Kiddie Tax rule applied only to children younger than 14. But the age limit has risen twice in the past few years.
Now the Kiddie Tax includes dependents up to the age of 19 and those up to the age of 24 that are full-time students. Any investment income earned in excess of $2,000 will be taxed at the parents' higher tax rate.
Coverdell: New Name, Better Benefits
Coverdell Education Savings Accounts are qualified investment accounts that allow nondeductible contributions of up to $2,000 annually per beneficiary. Earnings in the account are not taxed, and as long as withdrawals are used for qualified education expenses, they are tax free as well. Assets in a Coverdell must be used before the beneficiary's 30th birthday. Keep in mind that the designated beneficiary of a Coverdell account is free to take withdrawals at any time, but any amount in excess of his or her qualified education expenses will be taxable as income.
A 10% additional federal tax may also apply.
Coverdells also have a special feature unavailable with 529 plans: Qualified withdrawals may be used to pay for an elementary, secondary or college education. Withdrawals from 529 plans can only be used for college expenses. Unlike
529 plans, Coverdells impose income eligibility limits on contributors. Single filers with modified adjusted gross incomes of more
than $110,000 and joint filers with incomes
of more than $220,000 cannot contribute.
Putting It All Together
When choosing a college investment vehicle, remember that it may not be a "one or the other" decision. It may make sense for you to contribute to more than one type of account.
Speak with your financial advisor about your particular needs.
1Prior to investing in a 529 plan investors should
consider whether the investor's or designated
beneficiary's home state offers any state tax or other
benefits that are only available for investments in
such state's qualified tuition program.
Protecting Your Assets
in Litigious Times
According to the National Federation of Independent Business, some 15 million lawsuits involving small businesses are filed in U.S. courts each year at an estimated cost to individuals and businesses of more than $35 billion.1
Certain professions, such as doctors, lawyers and accountants are increasingly the targets of such litigation. As a result, more wealthy individuals and families are seeking ways to protect their assets from creditors as part of their overall estate planning efforts.
One Goal, Many Approaches
Following are a few potential asset protection strategies that wealth holders may consider.
Spendthrift Trusts are used to protect
trust beneficiaries from the claims of
their creditors, be that creditor a spouse or another interested party. Such
trusts achieve this goal by limiting the beneficiary's access to trust principal:
If the beneficiary cannot gain full
access to trust assets, neither can his
or her creditors.
The terms of spendthrift trusts can vary widely based on the wishes of the individual setting up the trust (the grantor). For instance, the grantor may want the beneficiary to receive regular income from the trust or arrange to have the trust purchase goods and/or services on behalf of the beneficiary.
The grantor may also be concerned about the beneficiary's character and/or ability to manage funds responsibly and therefore wishes to deny them direct access to trust property. All trust benefits are distributed by the third-party trustee named in the trust.
Self-Settled Domestic Trusts, sometimes referred to as Delaware Trusts, are a variation on the spendthrift trust
theme. For years, wealthy individuals
and professionals have sought to
protect assets from creditors by setting
up offshore trusts in jurisdictions
such as the Cayman Islands. Now
15 states—Delaware, Alaska, Hawaii, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Oklahoma,
Rhode Island, South Dakota, Tennessee, Utah, Virginia and Wyoming—offer opportunities for individuals to obtain similar protection domestically.2
This type of trust allows the grantor to establish and fund an irrevocable trust while also being a trust beneficiary. A corporate trustee (that must be domiciled
in the state governing the trust) controls
the trust's assets, including possible discretionary distributions of income
and principal to the grantor, within the guidelines of the applicable state law.
When structured properly, a creditor may not be able to reach the assets held in a self-settled trust because the trustee—not the beneficiary—controls them.
Generation-Skipping Trusts (GST), also known as Dynasty trusts, can preserve assets for several generations while
avoiding estate taxes. An individual can fund a GST with as much as $5,340,000 (the limit for 2014) without triggering the federal generation-skipping transfer tax.
A GST protects assets for the grantor's grandchildren and future generations in
case of a divorce or a lawsuit brought by a beneficiary's creditors. And when structured
to include Delaware trust features (Delaware
is one of the few states that allows trusts
to continue for an unlimited duration), a
GST can grow and benefit generations of
the grantor's heirs indefinitely without
being subject to recurring gift, estate or generation-skipping taxes.
A qualified estate planning attorney can work with you to explore appropriate asset protection solutions for your situation.
LPL Financial Representatives offer access
to Trust Services through The Private Trust Company N.A., an affiliate of LPL Financial.
1Source: National Federation of Independent Business (NFIB), "How to Handle Frivolous Lawsuits," November 15, 2013.
2Source: "5th Annual Domestic Asset Protection Trust State Rankings Chart," April 2014, Copyright 2010-2014 by Steve Oshins.
When Moving IRA Money, Take the Direct Approach
A U.S. Tax Court ruling earlier this year reinforced the notion that for investors who want to move IRA money, the direct rollover is still your best bet.
Specifically, the court determined—and the IRS later
agreed—that the "once a year" IRA rollover rule applies to
all of an individual's IRAs, not to each separately. Up until
this time, the IRS's position had been that the rule applied separately to each IRA an individual owned, thus allowing multiple rollovers if taken from separate accounts during a 365-day period.1
Direct Versus Indirect: Know the Differences
It is important to note that the new ruling applies only to
indirect IRA rollovers, in which the account holder takes
a distribution from an IRA and receives a check for the distributed amount. It is then up to the individual to
redeposit the funds into the new IRA within the allotted
60-day period to avoid possible taxation and penalties
on the distributed amount.2
The court was clear in its position that individuals can still
use the direct rollover approach—also known as a trustee-to-trustee rollover—anytime without worry over the new once-per-year rule. With a direct rollover, the money goes directly from the existing IRA custodian/trustee to the new custodian without the account holder ever touching it.
There are no taxes, penalties or deadlines to worry about.
All things considered, direct IRA rollovers are the best
choice for most people. They offer the most simplicity, the
least paperwork and the continued benefit of uninterrupted
tax deferral. They also offer a broad range of investment
choices and significant flexibility for distribution planning.
What to Look for in a Rollover IRA
Keep in mind that not all rollover IRAs are created equal.
Key features you'll want to look for when shopping for a
rollover IRA are investment selection and flexibility and account access and control.
Selection—Investment options may differ considerably
from one financial institution to the next, so when weighing different products it is important that you select a rollover IRA with investment choices that you like. Why? Because the better the investment selection, the better your chances of creating an ideal asset allocation for pursuing your goals.3
Flexibility—The more flexibility you have when it comes
to managing your investments, the easier it will be to adjust your strategy in response to your changing goals, time frame
or risk tolerance.
Account access and control—You will also want to make sure you have convenient access to real-time account information and performance data as well as live customer service.
Seek Professional Guidance
One final suggestion: Seek the help of a qualified, objective financial professional before committing your money to a
specific rollover IRA. A qualified professional can offer you the type of personalized guidance that can turn a good idea into a prudent financial strategy. And, depending on your needs, your relationship with a financial advisor could continue well beyond the establishment of your rollover IRA, to include conducting annual portfolio reviews and ensuring that your investment initiatives remain appropriate and on track.
1Source: InvestmentNews, "A Warning on Multiple IRA Rollovers," March 16, 2014.
2Distributions made prior to age 59½ may be subject to an early withdrawal penalty tax.
3Asset allocation does not assure a profit or protect against a loss.
An Expense Most Retirees Didn't See Coming
New research that explored how individuals plan for and manage living expenses in retirement found a majority of retirees had not factored in the effect of taxes on their retirement income prior to retiring.
Specifically, when pre-retirees were asked what they thought their major expenses would be in retirement, a majority indicated "home and mortgage," "healthcare" and "travel/leisure" in that order. However, when the same question was asked of retirees, the top three responses were "home and mortgage," "taxes" and "travel/leisure." On average, when taking all annual expenses into consideration, retirees reported that federal income taxes took the biggest bite out of their budgets.
More than a third (36%) reported that taxes consumed a larger portion of their income than they had anticipated—and nearly one-in-four (23%) had not even considered taxes as an expense prior to retiring.
Actions to Minimize Taxes
When the same group was asked what actions they
had taken to mitigate their tax exposure, itemizing deductions on their tax forms was the leading response with 35% of retirees. Trailing at a distant second was utilizing tax-deferred investments at 13%, and purchasing an IRA at 9%.
Source: Lincoln Financial Group, "2013—Expense Challenges of Ages 62-75 Retirees,"
June 5, 2014.
Planning Is Paramount
Given the current environment of higher tax rates—including new federal laws to restrict or eliminate personal exemptions and itemized deductions for high-earning Americans—now is the time to start devising strategies to
protect your investment portfolio and retirement income from increased exposure to taxation. Contact your financial advisor to learn more.
This communication is not intended to be tax advice and should not be treated as such. Each individualís tax situation is different. You should contact your tax professional to discuss your personal situation.
The opinions voiced in this newsletter are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested in directly.