Morningstar Advisor - Summer 2008 - (Page 46)

Spotlight graduate school unless circumstances suggest it is likely to happen. Statistics on the prices of colleges are available in the College Board’s annual report “Trends in College Pricing.” Also, take care to not overestimate the financial aid that may be available. Another annual report by the College Board, “Trends in Student Aid,” or any number of Web sites, can help in realistically assessing financial aid. Further, keep in mind that about one half of all financial aid is in the form of loans, not grants. 3. Consider Paying Tuition Out of Pocket including earnings on the account, minus the portion of the distribution that the account owner personally contributed to the account. For example, say a grandparent contributed $50,000 to a 529 savings account for a grandchild and the account appreciated to $100,000, but the grandchild decided not to attend college. If the grandparent took a nonqualified distribution of the full amount of the account, $50,000 (the earnings) would be subject to income tax and the 10% additional tax. On the other hand, if a grandparent named the parent as the account owner and the parent took the full nonqualified distribution, the parent would pay income tax and the additional tax on the entire amount of $100,000, because the parent did not contribute to the account. Although it is only a proposal, the possibility that the rule may become effective makes it advisable to name the contributor as the account owner whenever possible. 5. Think Carefully About the Successor Account Owner A third alternative is to make the 529 account a custodial account under the Uniform Transfers to Minors Act, which would prevent the account owner from withdrawing the money or changing the beneficiary. A custodial 529 savings account, however, requires that the beneficiary become the account owner when he or she reaches the statutory age (age 21, generally)--an occurrence that the contributor may not want, especially if the beneficiary is not pursuing further education. 6. File a Gift Tax Return, If Required It might make estate-planning sense for a parent or grandparent to plan on paying tuition (but not room, board, books, or other expenses) directly to the institution. Directly paying tuition allows clients to reduce their taxable estates, and under a special provision of the Internal Revenue Code, the payment does not count as a gift. It also does not reduce the amount (currently $12,000) that can be given annually to a beneficiary without gift tax or the contributor’s lifetime exclusion (currently $1 million). Keep in mind that if your client goes the direct-tuition-payment route, less money will be needed in a 529 savings account to pay for other qualified higher education expenses. Again, take care to not overfund the 529 account. 4. Make the Contributor the Account Owner A gift tax return must be filed if gifts, including any contributions to a 529 savings account, to any beneficiary exceed $12,000 in a calendar year. A husband and wife can each separately give $12,000 per year to a beneficiary. If either gives more than $12,000, even if the total is less than $24,000, a gift tax return must be filed to make the split-gift election. File a gift tax return if you wish to make the five-year election to treat contributions to a 529 savings account as if they were made pro rata over five years. The five-year election is not automatic. If spouses make a split-gift election, both spouses must file a gift tax return to make the five-year election. In the Jan. 18 Advance Notice, the IRS proposes to permit the five-year election to be made on a late-filed gift tax return if no gift tax returns for such year had been previously filed. 7. Consider the State Income-Tax Deduction When a grandparent (or any another person other than the beneficiary or the beneficiary’s parent) makes the contributions, name the contributor as the account owner to prevent the 529 savings account from being considered an asset by financial-aid programs. If the parent is the account owner, the account will be treated as a parental asset. Another reason to name the contributor as the account owner arose early this year. In an Advance Notice of Proposed Rulemaking on Section 529 published in the Federal Register on Jan. 18, the IRS proposes to tax the amount of a nonqualified distribution to an account owner, When setting up a 529 plan, name a successor account owner, and select such person with care. The successor account owner generally will have the power to not only change the beneficiary but also to withdraw and keep the 529 account funds, regardless of the wishes of the original contributor or the beneficiary. An account owner has no fiduciary duties to the beneficiary, so the beneficiary has no grounds for complaint. To avoid any unpleasant surprises, be sure the successor account owner is someone who the contributor is confident will carry out his or her intent. Alternatively, you could name a trust as successor account owner, which would impose fiduciary duties on the trustee to carry out the terms and purposes of the trust. Special provisions, however, should be included in t he trust dealing with the 529 account, and the income and transfer tax consequences of a trust being the account owner should be carefully considered. Thirty-four states now offer their residents a state income-tax deduction (or in some cases, credit) for contributions to the home state’s 529 plan, but many do not give a deduction or credit for contributions to other states’ plans. (A few states, such as Arizona, Kansas, Maine, and Pennsylvania, have deductions for contributions to any state’s plan.) But don’t automatically assume that plans in states that offer a tax deduction are the best choices. Carefully evaluate the financial benefit of the deduction and consider any limits 46 Morningstar Advisor Summer 2008

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Morningstar Advisor - Summer 2008 Contents Letter from the Editor Contributors Inbox College Planning: Solutions and Concerns ETFs: The Next Chapter Engineering Financial Advice Investment Briefs Flexible vs. Style-Pure Managers: The Evidence Forging a New Commodity Index Work Your Way Through College Planning Sizing Up the Options Best and Worst 529 College-Savings Plans A 529 Travel Guide 10 Tax-Smart Tips for College-Savings Planning Global Dialogue How Sequoia Cranks Out Good Returns Year After Year The Many Layers of David Winters Living on the Edge Stocks to Buy Once a Decade With Munis Feeling the Pain, Some Opportunities Arise Health Care Provides Shelter from Economic Storm Help Your Clients Get More Out of Their Bond Portfolios Mutual Fund Analyst Picks 50 Most Popular Equity ETFs Undervalued Stocks Most Popular Variable Annuities New at Morningstar New on MorningstarAdvisor.com Closer to Fine

Morningstar Advisor - Summer 2008

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