ESTATE & TRUST PLANNING FOR EDUCATIONAL EXPENSES First Run Broadcast: February 27, 2018 1:00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes) This program will provide you with a detailed review of the estate and trust alternatives for funding educational and related expenses for heirs. The program will cover the types of Section 529 plans available, including state-sponsored plans that are comparatively inflexible but taxfavored and private plans that are more flexible but might carry fewer financial incentives. The varying tax treatment of these vehicles form statutorily-defined plans to various types of trusts to custodial accounts will also be analyzed. Issues of control (how soon does a child or other beneficiary gain control of the funds, if ever?), the eligibility of beneficiaries, and what type of expenses may be covered by the plan will be discussed. This program will provide you with a framework for understanding the range of alternatives and the practical financial, tax and control tradeoffs of each alternative. Estate and trust planning alternatives for funding educational expenses Impact of new tax law on planning for education expenses State-sponsored v. Independent 529 Plans tax and control tradeoffs of each Coverdell Education Savings Accounts (ESAs) option for college and K-12 expenses Use of custodial accounts under UTMA and UGMA 2503(c) Trusts and the annual exclusion Impact of kiddie tax on funding educational expenses of children and grandchildren Crummey Trusts for multiple beneficiaries and children who are not minors Speaker: Blanche Lark Christerson is a managing director at Deutsche Bank Private Wealth Management in New York City, where she works with clients and their advisors to help develop estate, gift, tax, and wealth transfer planning strategies. Earlier in her career she was a vice president in the estate planning department of U.S. Trust Company. She also practiced law with Weil, Gotshal & Manges in New York City. Ms. Christerson is the author of the monthly newsletter Tax Topics." She received her B.A. from Sarah Lawrence College, her J.D. from New York Law School and her LL.M. in taxation from New York University School of Law.
VT Bar Association Continuing Legal Education Registration Form Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT 05601-0100. Fax: (802) 223-1573 PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name Middle Initial Last Name Firm/Organization Address City State ZIP Code Phone # Fax # E-Mail Address Estate & Trust Planning for Educational Expenses Teleseminar February 27, 2018 1:00PM 2:00PM 1.0 MCLE GENERAL CREDITS VBA Members $75 Non-VBA Members $115 NO REFUNDS AFTER February 20, 2018 PAYMENT METHOD: Check enclosed (made payable to Vermont Bar Association) Amount: Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # Exp. Date Cardholder:
Vermont Bar Association CERTIFICATE OF ATTENDANCE Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: February 27, 2018 Seminar Title: Location: Credits: Program Minutes: Estate & Trust Planning for Educational Expenses Teleseminar - LIVE 1.0 MCLE General Credit 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.
PROFESSIONAL EDUCATION BROADCAST NETWORK ESTATE & TRUST PLANNING FOR EDUCATIONAL EXPENSES Material submitted by: Blanche Lark Christerson Deutsche Bank Wealth Management - New York City (o) (212) 454-1039 blanche.christerson@db.com
Tax Topics 05/31/17 2017-05 Saving for College Blanche Lark Christerson Managing Director, Senior Wealth Strategist It s been four years since we did a round-up of some of the ways to save for a child s college education. Various options are available, but the impact of the socalled kiddie tax, along with the 3.8% tax on net investment income, must be considered in assessing these options, along with the recognition that any savings vehicle may affect financial aid eligibility, a discussion of which is beyond the scope of this piece. Nevertheless, not saving does not seem like an option unless one is in such dire straits that setting money aside is not possible or there is enough family wealth that higher education costs are not a concern. Before getting into a selected overview of savings vehicles, here is some background: The kiddie tax. Originally enacted in 1986, the kiddie tax was designed to prevent income-shifting between parents and children. For years, the tax only applied to children under the age of 14, but in 2006 and 2007, Congress broadened the tax s reach, so that it now applies to children under age 18 and, if they don t earn over half of their own support, to 18 year-olds and to full-time students, from ages 19 to 23. Thus, if these children have unearned income such as interest, dividends and capital gains in excess of $2,100 (the same inflation-indexed number since 2015), this income will be taxed at their parent s highest rate, which can top out at 39.6% for ordinary income, and 20% for qualified dividends and long-term capital gains. This is in contrast to the much lower rates that might otherwise apply to the child s unearned income such as 0% for qualified dividends and capital gains if the child were in the 0% or 15% income tax bracket. The kiddie tax thus makes custodial accounts (see below) less attractive and tax-protected vehicles such as 529 plans more attractive. (Note that if parents elect to report their child s unearned income on their own income tax return, that income will factor into the parents calculation for the 3.8% tax on net investment income discussed below.) The 3.8% tax on net investment income. As of 2013, a 3.8% tax on net investment income such as interest, dividends, capital gains, annuities, royalties and rents applies (i) to individuals whose modified adjusted gross income (MAGI) exceeds certain amounts ($125,000 for married, filing separately;
$200,000 for single taxpayers; $250,000 for married joint filers) and (ii) to most trusts and estates. (MAGI refers to adjusted gross income plus otherwise excluded foreign income.) Although the 3.8% tax may be repealed under the Trump Administration, for the moment, it is still a consideration. Note that 529 plans and Coverdell ESAs are not subject to the tax. Financial aid. As mentioned above, any savings vehicle may affect a student s financial aid eligibility. It is difficult to generalize about this topic, as the rules frequently change, and can vary considerably from school to school. Nevertheless, FAFSA, which stands for the free application for federal student aid, is a good place to begin investigating how resources are weighted in the financial aid calculation, as is the CSS/Financial Aid Profile, which evaluates resources differently than FAFSA, and is used by many schools. Here, then, is an overview of some of the ways to save for a child s college education. Although the focus is on Mom and Dad, it could also be Grandma and Grandpa, who may be in a better position to make gifts (note that a donor need not be related to someone to create a vehicle for that person s benefit). 529 plans. Named after the section of the Internal Revenue Code that authorizes them, 529 plans are taxadvantaged vehicles to finance the costs of higher education. All 50 states have them, and the particulars of each plan vary, including the maximum contribution levels and fees (out-of-state plans or those purchased through an investment advisor can have significant sales loads). Although contributions to 529 accounts are not deductible against the federal income tax, they may be eligible for a state income tax deduction. The plans are tax-advantaged in that the money invested in them grows tax-free and withdrawals for qualified higher education expenses a broad term that includes tuition, room and board, books and fees for college and graduate or vocation school are free from federal income tax, and may be free from state income tax as well. Note that the account is listed on FAFSA, whether Mom or her child owns it, but is not listed if Grandma owns it; nevertheless, a distribution from Grandma s account will count as the child s untaxed income in the subsequent year for FAFSA purposes, thereby weighing against the child. Pros: If Mom has money to spare, she may front-load a 529 plan for Son, and make five years worth of annual exclusion gifts in one year. Thus, in 2017, Mom can contribute $70,000 (5 x $14,000, or $140,000 if Dad agrees to split the gift). The gift won t erode any of Mom s $5.49 million applicable exclusion amount (this protects transfers from gift or estate tax), and gives her a jump on tax-free growth. (If Mom makes additional gifts to Son during this five-year period, these gifts will erode her applicable exclusion, and if she dies, say, in Year 3 of this period, the unused gifts for Years 4 and 5 will be includible in her estate.) Even though Mom may change plan beneficiaries this might happen if Son isn t interested in school but Daughter is the plan won t be includible in Mom s estate if she dies before the account is depleted; if the new beneficiary is a family member and in the same (or higher) generation as the former beneficiary, there will be no gift or generation-skipping transfer tax consequences. If Mom later needs the money, she may withdraw her contributions, subject to a 10% penalty and income tax on the account s earnings. Finally, unlike custodial accounts and trusts (see below), 529 plans generally appear to count less heavily against the beneficiary for financial aid purposes. In short, 529 plans offer some unique advantages. Cons: Mom cannot control the plan s investments, and can only select from the plan s investment options (she may rebalance the account twice a year). Some plans carry significant sales loads; this may be more costly than if Mom had simply invested the money herself. Also, if Mom switches from one state plan to another, the initial state may impose a tax or penalty on the account, particularly if it generated any state income tax deductions. Finally, the Pension Protection Act of 2006 directed the Treasury Department to Tax Topics 05/31/17 2
issue regulations to ensure that taxpayers don t abuse 529 accounts for estate and gift tax and generationskipping transfer tax purposes. Although the regulations haven t yet been issued, they could curtail some of the account s flexibility by limiting Mom s ability to change beneficiaries and make non-qualified withdrawals. The following websites may be helpful: http://www.collegesavings.org/ this is a springboard to each state s 529 website http://www.savingforcollege.com/ this provides a breakdown of each state s different programs, including costs http://529.morningstar.com/state-map.action this has good basic material on 529 plans (detailed Morningstar investment analyses of plans requires registering and paying for the site) Private College 529 Plan. Formerly called The Independent 529 Plan, the Private College 529 Plan entered the saving for college field in 2003. The Private College Plan is a consortium of nearly 290 private colleges and universities that allow contributors to purchase tuition certificates that lock in participating schools future tuition costs at today s prices. As with a regular 529 plan, Dad may front-load the Private College Plan with five-year s worth of annual exclusion gifts, and change beneficiaries. Dad may only use these Plan dollars for undergraduate tuition and mandatory fees, however not for room and board or graduate or vocational school tuition. Also, there is now a 36-month waiting period for each tuition certificate Dad purchases, so that he can t use it immediately. Dad doesn t assume any investment risk (the participating schools do) and is guaranteed that a participating school will honor the certificates, even if a school no longer participates in the program when Dad redeems a tuition certificate. If Dad s child does not enroll at a participating school (or is rejected), Dad is entitled to a refund, adjusted for investment performance (up or down) by a maximum of 2%, compounded annually. (In other words, if the portfolio was up by 10%, Dad would only get 2%; if it was down by 4%, Dad would only be down 2%.) The earnings portion of the refund is subject to income tax and a 10% penalty. To avoid that result, Dad can roll the dollars (adjusted for investment performance) into a regular 529 plan. According to the plan s brochure, tuition certificates may have a material adverse effect on financial aid eligibility; as of July 1, 2009, tuition certificates are considered an asset of the parent if the student is a dependent, and as an asset of the student if the student is not a dependent (the same treatment afforded a regular 529 plan). Pros: The Private College Plan locks in the future tuition costs of participating private colleges and universities at today s rates. Unlike some regular 529 plans, the Private College Plan permits contributions from the following persons : trusts, estates, partnerships, associations, companies, corporations or other entities. Thus, for example, Dad could contribute some or all of a child s custodial account (see below) as long as he first liquidated it. For those wishing to put fetters on custodial dollars, this could be attractive (note that Dad can no longer switch beneficiaries if the 529 dollars come from a custodial account). Cons: If Dad s child does not go to a participating school, the tuition lock-in becomes irrelevant, and his investment returns may have been better if he had put his dollars elsewhere. As mentioned above, the account may only be used for tuition and mandatory fees at an undergraduate institution. In addition, because each tuition certificate must season for at least 36 months before use, Dad s ability to lock in tuition costs once he knows his child will be attending a participating school has been seriously curtailed. Finally, it is impossible to know how discounted tuition dollars may affect the financial health of participating schools, and whether they may be forced to impose additional fees or adopt tiered pricing to cover any potential future shortfalls. Tax Topics 05/31/17 3
Here is the website for the Private College 529 Plan: https://www.privatecollege529.com/ofi529/ Coverdell Education Savings Accounts (ESAs). Originally, these accounts were known as Education IRAs and could only accept contributions of $500 per year. ESAs have now been permanently expanded, so that Mom may contribute $2,000 per year and may use the funds for elementary and secondary school expenses (i.e., K 12 ) as well as the same kinds of qualified higher education expenses mentioned above under 529 Plans. Mom can t contribute to an ESA if her modified adjusted gross income (MAGI) exceeds $220,000 (married, filing jointly) or $110,000 (single taxpayer); her contribution is phased out if her MAGI is between $190,000 and $220,000 (married, filing jointly) or between $95,000 and $110,000 (single taxpayers). (MAGI refers to adjusted gross income plus otherwise excluded foreign income.) Contributions are not taxdeductible, but are permissible even if Mom contributes to a 529 plan in the same year. The ESA grows taxfree, and earnings on qualified withdrawals are tax-free; earnings on nonqualified withdrawals are subject to income tax and a 10% penalty. As with a 529 plan, Mom may change beneficiaries. Pros: As mentioned above, Mom may use the account for K 12 expenses (unlike a 529 plan). She may also direct the account s investments and therefore may have lower fees. Cons: Unlike a 529 plan, an ESA may not accept contributions once the beneficiary reaches age 18, and the account must be distributed by the time the beneficiary reaches age 30 (these age limitations do not apply to special needs beneficiaries). Also, the most Mom can contribute is $2,000 per year, provided her income doesn t exceed the amounts above. Custodial Accounts: UTMA and UGMA. Custodial accounts refer to accounts under UTMA (Uniform Transfers to Minors Act) and UGMA (Uniform Gifts to Minors Act). They are an easy way to give property to a minor child, whether Dad wants to set aside money for college or simply get property out of his estate for planning purposes. Many states have gone from UGMA to UTMA, a broader and more flexible Act. In states where this has occurred, the UGMA account is now governed by UTMA, except as to when the account must terminate. Thus, even though UTMA accounts typically terminate when the beneficiary reaches age 21, UGMA accounts usually terminate at age 18, unless Dad specified age 21 when he set it up. This means that if Dad s age 18 UGMA is now governed by UTMA, he is still locked into the age 18 termination. UGMA and UTMA accounts are currently taxable to the beneficiary, and are subject to the kiddie tax mentioned above; given the expanded scope of this tax, custodial accounts are even less attractive. The bottom line: custodial accounts, unlike 529 plans and ESAs, do not offer tax-deferred growth. Pros: Custodial accounts are a simple way to set aside funds for a child. The custodian may use the account to benefit the child in any way he sees fit, as well as direct the investments. Cons: Custodial accounts can accumulate significant dollars that Dad may be reluctant to see fall into the hands of his 18- or 21-year-old. If Dad uses the account to help support his child, he ll be taxable on the income from those funds (the kiddie tax probably makes this point moot). Because the child owns the property, it is the child s asset for financial aid purposes. Dad may not reclaim the property in the account, something he can do with a 529 plan or an ESA (subject to the adverse consequences described above, and the possible restrictions that future regulations may impose). Finally, if Dad funded the account and is the custodian, the account will be included in Dad s estate if he dies before the account is turned over to the child at age 18 or 21. 2503(c) Trusts. A 2503(c) trust is for a minor, and is designed to receive annual exclusion gifts (currently $14,000 per year, or $28,000 if the donor s spouse consents). The trust (i) doesn t require Crummey letters Tax Topics 05/31/17 4
when Mom contributes to the trust (see Crummey Trusts, below), (ii) is solely for the child for whom it is created, and (iii) is taxable in the child s estate if he dies before the trust terminates. When the child reaches age 21, the trust must either terminate or give the child an opportunity (say, for at least a month) to withdraw all of the trust s assets (if assets are not withdrawn, the trust will continue for however long the document says). The trust is generally a separate taxpayer, and is taxable on its earnings until the child reaches age 21. If the child reaches that age and doesn t terminate the trust, he now owns it for income tax purposes (yes, it becomes a grantor trust as to the child); the kiddie tax may apply. Although trusts benefit from the preferential rates for qualified dividends and capital gains, they have extremely compressed rate brackets and in 2017, are subject to the top 39.6% tax rate at taxable income over $12,500. In addition, trusts are subject to the 3.8% tax on net investment income (see above), which applies to the lesser of a trust s undistributed net investment income or its adjusted gross income minus $12,500 (again, the 2017 threshold for the 39.6% income tax rate). Trusts are generally considered the child s asset for financial aid purposes. Pros: As mentioned above, annual exclusion gifts into the trust do not require Crummey letters. Also, the trust can be as flexible as Mom wants, unlike a 529 plan or an ESA. Cons: The child can terminate the trust at age 21. An attorney must draft the trust, which requires trustees and separate tax reporting. For that reason, trusts are more complicated and potentially less costeffective than any of the other options described above. Crummey Trusts. Like the 2503(c) trusts mentioned above, Crummey Trusts are designed to receive annual exclusion gifts. The trusts are not limited to having one minor beneficiary, however, and can have multiple beneficiaries of any age. If Mom sets up a Crummey Trust for Daughter, the trustee must write annual letters to Daughter, informing her when Mom puts money in the trust during the year, and explaining that for a limited time (say, 30 days) Daughter may withdraw the money (it s generally intended that Daughter won t exercise this right). This right of withdrawal is called a Crummey power (after the taxpayer who litigated the issue) and is what makes Mom s gift into the trust a present interest that qualifies for the annual exclusion and does not erode her $5.49 million applicable exclusion amount. The trust can include whatever provisions Mom likes, and can last well beyond Daughter s lifetime. The trust is generally a separate taxpayer unless Mom has structured it to be taxable to her (a defective grantor trust ) note that the trust or Mom may be affected by the 3.8% tax on net investment income. Pros: Mom only has to worry about Daughter withdrawing Mom s contribution each year not the whole trust when she turns 21, as with the 2503(c) trust mentioned above. A Crummey Trust can be as flexible as Mom wants in terms of provisions and payouts. It provides a solid asset management structure, and makes sense if Mom anticipates that other significant gifts will go into the trust. Cons: Trusts, particularly those with Crummey provisions, are much more involved than 529 plans, ESAs, or custodial accounts. If Mom doesn t intend to put that much property into the trust, it s not worth it. It may be difficult to find a cost-effective trustee, and she ll find the annual Crummey notices a nuisance. She also needs to be careful about the control she retains over the trust, since she doesn t want it included in her estate if she dies before the trust terminates. Other points. Mom and Dad can deduct up to $4,000 worth of tuition and fees they pay on behalf of themselves or a dependent to an eligible educational institution, which includes college and vocational school. The deduction is subject to limits based on their modified adjusted gross income, and is unavailable if they claim certain learning credits for which lower-income taxpayers are eligible. Tax Topics 05/31/17 5
To learn more about other tax benefits relating to education, including the rules regarding scholarships, educational savings bonds and the deductibility of student loan interest, take a look at the IRS s very helpful Publication 970, Tax Benefits for Education. It is available on the IRS s website at: https://www.irs.gov/pub/irs-pdf/p970.pdf Conclusion. Saving for a child s education requires planning and a financial commitment. Although there are various ways to finance an education, there is no one right answer just choices and what makes the most sense in a given situation may depend on how much Mom and Dad intend to put aside and whether they want the funds strictly for educational expenses. Keep in mind that only 529 plans and ESAs permit contributed money to be reclaimed (subject to penalties); the other gifts are all irrevocable and belong to the child. Because of that, they generally count more heavily against the child in financial aid calculations more so than if Mom and Dad simply set the money aside in their own names. Although a segregated education account has a certain appeal (Mom or Dad controls it absolutely), such easy access may mean that the account is depleted long before a child goes to college. A vehicle that puts some barriers around the money, such as a 529 plan, therefore may be beneficial. It goes without saying, however, that if generous relatives or friends are in the picture, those people can make direct tax-free payments of tuition to a child s school yes, even nursery school in addition to any annual exclusion gifts they might give. That might be the best solution of all! June 7520 rate The June 2017 7520 rate remains at 2.4%, where it was in May. The June mid-term applicable federal rates (AFRs) are also down slightly: 1.96% (annual), 1.95% (semiannual and quarterly), and 1.94% (monthly). The May mid-term AFRs were 2.04% (annual), 2.03% (semiannual), and 2.02% (quarterly and monthly). Blanche Lark Christerson is a managing director at Deutsche Bank Wealth Management in New York City, and can be reached at blanche.christerson@db.com. The opinions and analyses expressed herein are those of the author and do not necessarily reflect those of Deutsche Bank AG or any affiliate thereof (collectively, the Bank ). Any suggestions contained herein are general, and do not take into account an individual s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. No warranty or representation, express or implied, is made by the Bank, nor does the Bank accept any liability with respect to the information and data set forth herein. The information contained herein is not intended to be, and does not constitute, legal, tax, accounting or other professional advice; it is also not intended to offer penalty protection or to promote, market or recommend any transaction or matter addressed herein. Recipients should consult their applicable professional advisors prior to acting on the information set forth herein. This material may not be reproduced without the express permission of the author. "Deutsche Bank" means Deutsche Bank AG and its affiliated companies. Deutsche Bank Wealth Management represents the wealth management activities conducted by Deutsche Bank AG or its subsidiaries. Trust and estate and wealth planning services are provided through Deutsche Bank Trust Company, N.A., Deutsche Bank Trust Company Delaware and Deutsche Bank National Trust Company. 2017 Deutsche Bank AG. All rights reserved. 025748 053117 Tax Topics 05/31/17 6