Tax Tip: Choosing the Right College Savings Plan

529This time of year, everyone is looking to find ways to avoid large tax burdens. Contributions to your child or grandchild for college savings may be a great way to plan for the future and get some tax relief right away. As a college savings tool, 529 plans are the most popular choice to maximize tax-free growth of your investment, as long as it is used entirely for qualified secondary educational expenses. An individual can contribute up to $70,000 and a couple up to $140,000 to one beneficiary in a single year, as long as they count it towards their annual gift tax exclusion over a five year period. Many of the 529 plans allow for maximum account values of over $300,000. The 529 contributions are considered an asset of the custodian, allowing for flexible financial aid qualification for the student and transfers of the funds between accounts for other beneficiaries. Each state has its own plan and investment module and many offer tax benefits for contributions by residents. If your state does not offer tax incentives, then you are free to invest in any of the top-performing 529’s in other states, as most plans do not have residency requirements to participate. DWM can help find the best direct-sold plans with low operating expenses and good allocation menus. South Carolina’s direct sold plan ranks in the top 10 and Illinois in the top 15 for the last 5 years and both offer tax incentives for residents.

Before the 529’s were created, the investment choice for many was the Uniform Gift to Minor Acts (UGMA) or Uniform Transfer to Minors Act (UTMA) custodial accounts. These plans offer the advantage of allowing for non-qualified educational expenses without penalty. For example, if you want to use the funds to buy a car for your teenager. The UGMA/UTMA accounts also offer a full range of investment options with the ability to choose allocations and make changes as you would with any other investment account. There is also no limit on the maximum contribution amount. UGMA/UTMA accounts are taxed on their growth and mandated by the rules of the “kiddie tax”. This tax provision allows for the first $1,000 of unearned income of the minor to be tax-exempt and then the second $1,000 is taxed at the young account holder’s lower tax rate. Any gains from investment growth, dividends or interest above that $2,000 unearned income limit will be taxed at their parent’s higher tax rate. This tax provision affects all account holders under 19 or dependent full-time students between ages 19-23.

So what happens if you are the custodian for a UGMA/UTMA for a minor child or grandchild and you want to move it to a 529? 529’s can only accept cash deposits so the account will have to be liquidated and the custodianship terminated. The irrevocable provisions of the beneficiary arrangement in Uniform Minor acounts, however, must still be maintained, even in the 529. The 529 will ask for the source of the funds, and, if coming from a UGMA/UTMA, some 529 plans will register it as a Custodian 529. This simply means that the beneficiary rules designate the account holder be given control of the asset at age 18. The same Uniform Minor laws apply regardless of what kind of account these funds transfer to because the original asset was in an irrevocable account. Funds cannot be transferred or used by siblings or other family members without a penalty.

Is it prudent to move the funds into a tax-exempt 529? The biggest consideration are the taxes created by the liquidation of the UGMA/UTMA account and/or the annual taxes owed by the minor during its operation. After evaluating the potential gains to be made during the life of the account, you must consider what the tax on those gains will be. You can choose to liquidate the account in pieces over time or all at once, depending on the tax burden created. The tax must be paid at some point, so perhaps sooner rather than later will prevent it from increasing. Another choice is to leave the assets where they are and put any additional contributions in a new 529 for the beneficiary. This will avoid causing a taxable event while creating a beneficial 529 account. There may be a tax benefit to transferring the funds into a state-sponsored 529 plan because of tax breaks offered by some states, like South Carolina and Illinois. The tax owed on the gains may be offset by the tax incentives offered. You will have to weigh the implications of the long-term tax-saving benefit of transferring into a 529 against the tax burden created by liquidating the account.

While it’s true that the 529 is an excellent college-saving tool, there can be advantages to using the Uniform Minor accounts as well. And a conversion of a UGMA/UTMA account to a 529 can be a complex decision. At Detterbeck Wealth Management, we can help you evaluate your situation to determine the best option.

Estate Planning – Put Yourself in Charge!

estate plan ducks in a rowTalking about death is uncomfortable and estate planning is one of those topics that no one really likes to discuss. This fall, we were saddened at the passing of three clients and helped their families work through the process of tying up their estates. It reiterated how important these discussions and plans really are. More than half of Americans don’t have wills or any sort of estate plan in place. Estate planning attorneys call this the “do-nothing” approach and the technical term for having no plan when you die is called “intestate”. Basically it means that everything you own, all of your assets that you have accumulated and imagined leaving to your heirs someday, will now be appraised, managed and distributed through the probate court system, not by your family or beneficiaries. As you can imagine, there are tremendous fees and legal costs to this process, requiring probate attorneys for public and lengthy reviews by the court system. In South Carolina, for example, a probate account must remain open for at least 8 months and assets can be frozen while it is sorted out. The process can take well over a year or more to settle the estate.

Aha! So we will just have a Last Will and Testament that spells out all of our wishes, you say. It’s true, a will helps set out the guidelines for how you want your estate to be distributed. However, the will is still administered by the probate court, not your family, and it becomes public upon your death. All of the costs associated with probate will still be there. Probate fees can run as much as 5% of your gross estate value, assessed on the total even before all of your liabilities are paid off! Probate court is not just for estates of the deceased, either. There is a Living Probate, which means your estate can go to probate if you are alive, but become mentally incapacitated. Then the probate court steps in to appoint an agent to control all your personal affairs in a “conservatorship.” This may become more of an issue as people are living longer and we face increased age-related cases of Alzheimer’s or dementia.

You may also have some of your assets titled in Joint Tenancy, short for Joint Tenancy With Rights of Survivorship (JTWROS). The right of survivorship gives ownership to the last remaining owner. Married spouses will often hold property this way so that their asset will automatically transfer to their spouse or joint owner. However, once both of the spouses or both owners have died, the asset, unless it was retitled earlier, will still have to go through probate. And neither a will nor the Joint Tenancy will prevent a Living Probate if one of the owners becomes incapacitated.

One good way to protect your assets and make sure they are managed and distributed the way you wish is to establish a Revocable Living Trust. Used in conjunction with your will, it controls all your assets while you are alive and after your death. Basically, you title all of your assets to your trust, and, with the trust as owner, you (or you and your spouse or others) are your own trustee(s), which means you control your assets just the same as you do now. IRA’s and 401K’s are treated separately and won’t be titled in the trust. You will then designate a successor trustee to take over and manage everything when you die. But when that happens, the assets are not in your name, they are owned by the trust and so there is no need for probate. The successor trustee immediately steps in as your estate manager and can distribute or manage your assets as you have designated. You can also write instructions of how to manage things should you become incapacitated, avoiding the need for a Living Probate. It is a win-win.

Take some time to look at your current estate plan, titling of all assets and all beneficiary designations. Discuss with your financial advisor, perhaps at Detterbeck Wealth Management, and your estate planning attorney the best way to protect and title them. It can take some work to track down lost stock certificates, deeds or account numbers, but it will be worth it in the time, angst and costs saved by avoiding probate. Your loved ones and beneficiaries will be grateful.

Grim(m) Waters: Will New Flood Rate Legislation Help Property Owners Stay Afloat?

Floating houseThere has been much discussion and legislative wrangling about flood insurance rates and how properties rated for high flood risk should be paying to insure that risk. In 2012, the Biggert-Waters Flood Insurance Reform Act eliminated flood insurance subsidies for those properties and sought to introduce true risk ratings for all properties needing flood insurance. This generates some huge increases in premiums for some of the most at-risk areas and could leave many affected owners unable to afford their properties and dampen home sales in those areas. Hundreds of small river towns and coastal communities in every state with significant numbers of homes and businesses in flood hazard zones are at risk. There are about 5.5 million policies in force today, about 20 percent of which are subsidized. New 2014 legislation will delay many of the increases to help minimize some of the immediate negative impact.

Congress created the National Flood Insurance Program in the late 1960s, in part because private insurers had abandoned the market. Today, in most places, it is the only option for buying flood insurance, which is required for most mortgages on any property in a flood hazard zone. There are two ways that insurance rates can be affected. First there is the system used by the NFIP to rate properties according to their base flood elevation (BFE) and the lower the elevation level, the higher the risk for those properties. Many insurers are now requiring elevation certificates at renewal. Another way is through Flood Insurance Risk Maps or FIRM. New FIRMs are being issued nationwide. When the new FIRMs take effect, some residents and business owners will learn that their properties’ flood risks have changed and that their homes or buildings have been mapped into high-risk flood zones. In order to combat the cost of higher premiums for these properties, the government has previously provided subsidies on the high hazard properties or on those that were built before the flood rate maps were drawn in 1975, also called Pre-FIRM properties. Previously, these properties were allowed a “grandfathered” rating offering lower and subsidized premiums. The 2012 legislation was enacted in an effort to eliminate the large accumulated debt carried by FEMA through the NFIP after recent significant storm claims, in large part from Hurricane Katrina and Superstorm Sandy. The law eliminates grandfathering and subsidies for the flood hazard areas. Legislators felt the rates should reflect the true cost of the risk and wanted to use the increased premiums to reduce the Programs’ debt.

However, in response to an outcry by property owners who sometimes have seen their flood insurance bills increase by 5-10 times current premiums, new legislation signed in early March by President Obama reverses or postpones some of the increases from 2012. This new 2014 Grimm-Waters bill will allow for gradual increases to the full actuarial rates, restoring the “grandfathering” and capping annual increases between 5%-15%. Still, some secondary homes or businesses and severe repetitive flood claim properties will see premiums increase by 25% annually until the actual targets are met. Although the new legislation was signed, it will take FEMA and the insurance carriers several months to put the reduction policies in place. The new legislation also calls for refunds of increased premium payments generated under the existing legislation. Property owners are eligible for a refund once the new requirements are processed.

Some communities, like Charleston, SC, have undertaken proactive ways to improve their flood rating and help residents lower their premiums. The National Flood Insurance Program’s (NFIP) Community Rating System (CRS) is a voluntary incentive program that recognizes and encourages community floodplain management activities that exceed the minimum NFIP requirements. Communities are given certain points for public information or city regulations, for example, and then given a rating. A decrease for a community’s class rating can translate to as much as a 20% savings in premiums.

Flood insurance is necessary for many communities in these hazardous waterfront zones. Legislators are working to balance the cost for the affected individuals with the burden to the taxpayers for carrying flood subsidies. Certainly, the goal is to minimize the economic impact that higher premiums have on the housing market and help property owners keep their heads above water… It is a work in progress as they put these regulations in effect.