SIE - Retirement Plans Pt. 3

When discussing a 529 Plan with a client, which statement can be made?

"The amount contributed to the plan will not be deductible from federal income tax, but it is usually deductible from state income tax" 529 Plan contributions are not deductible at the federal level. However, most states that have income taxes allow a deduction for contributions made to a plan established by that state. This is a tax benefit of making 529 Plan contributions. Each state imposes its own limit on how much can be contributed to a 529 Plan. Any unexpended funds in the account can be given to another family member to pay for their college and maintain tax-deferred status, but if there are funds that are not used, they become taxable (on the growth in the account plus a 10% penalty tax, because the contribution was made with after-tax dollars).

The maximum annual contribution to a Coverdell Education Savings Account is:

$2,000 The maximum annual contribution to a Coverdell Education Savings Account for a single beneficiary is $2,000.

Distributions from a Coverdell Education Savings Account must cease when the beneficiary reaches the age of:

30 Distributions from Coverdell Education Savings Accounts must stop when the beneficiary reaches age 30. Any unexpended funds can be transferred to another related beneficiary (under age 18) for his or her qualified education expenses.

High-earning parents would like to invest in equities to fund their child's higher education expenses. The best investment choice would be a:

529 College Savings Plan High-earning individuals cannot contribute to a Coverdell Education Savings Account. High earning individuals who invest in U.S. Government Savings Bonds and use the interest to pay for higher education expenses are taxed on the interest at the federal level. Contributions to custodial accounts are not deductible regardless of income level and the earnings in the account are taxable annually - there is no tax benefit here, regardless of income level. Investments in 529 Plans are not federally tax-deductible, but the earnings grow tax-deferred, and distributions to pay for qualified higher education expenses are not taxable. This tax benefit is not subject to income phase-out rules, as is the case with Coverdell ESAs and U.S. Government Savings Bond investments to pay for higher education. (The interest earned when Series EE bonds are redeemed to pay for qualified education expenses is tax-free for lower income individuals.) (Also note that starting in 2018, up to $10,000 per year can be withdrawn from a 529 Plan to pay for education below the college level, and starting in 2020, up to $10,000 per year can be used to pay off qualified education loans, but these points are not part of this question.)

What type of education savings plan permits an adult donor to be the beneficiary?

529 Plan An unusual feature of 529 Plans is that the donor and the beneficiary can be the same person. There is no age limit on who can be the account beneficiary. Custodial accounts can only be opened by an adult for a minor. Contributions to a Coverdell Education Savings Account can only be made to someone who is below age 18.

Which statement is FALSE regarding Section 529 Accounts?

A Any adult can open an account for any beneficiary B Account contributions are not deductible, but earnings build tax-deferred C Non-taxable distributions may be made to pay for qualified higher education expenses Correct answer D Non-taxable distributions may only be made to educational institutions in the state that sponsors the plan Any adult can open a Section 529 account for a beneficiary. Contributions are not tax deductible, but earnings build tax-deferred. Distributions to pay for qualified higher education expenses are not taxable; and these distributions can be made to any qualified educational institution in any state.

Which statement is FALSE about both Coverdell ESAs and 529 Plans?

A Distributions from both are tax-free when used to pay for qualified education expenses B Contributions to both are not deductible from federal income tax C Tax-free distributions from both can be used to help pay for primary school Correct answer D There is no limit on the amount that can be contributed into each Contributions to Coverdell Education Savings Accounts (ESAs) and 529 Plans are not deductible. The maximum Coverdell ESA contribution is $2,000 per year per child. The maximum amount that can be contributed to a 529 Plan is set by each state - and the amounts are very high. Earnings in both build tax-deferred, and when distributions are taken to pay for qualified education expenses, they are tax-free. Funds in a Coverdell ESA can be used to pay for all levels of education, and also for vocational school. Funds in a 529 Plan were originally only allowed to be used to pay for college or higher, but now up to $10,000 per year can be used to pay for below-college level education expenses, and starting in 2020, up to $10,000 per year can be used to pay off qualified education loans.

Which of the following is a FALSE statement about 529 Plans?

A The donor maintains control over the assets in the plan B The contribution may be deductible at the state level Correct answer C The donor and the beneficiary cannot be the same person D Distributions to pay for qualified higher education expenses are tax-free An unusual feature of 529 Plans is that the donor and the beneficiary can be the same person. There is no age limit on who can be the account beneficiary. The other statements are true. The donor maintains control over the assets in the plan; the contribution made by the donor may be deductible at the state level (but not at the federal level); and distributions to pay for qualified higher education expenses (as well as up to $10,000 of below college education expenses annually) are tax free.

Which statement is TRUE about federal taxation of contributions to 529 plans?

A 1-time gift of up to 5 times the gift tax exclusion amount can be given that will not be subject to gift tax Contributions to 529 plans are not federally tax deductible. Any gifts above the annual gift tax exclusion amount ($15,000 in 2020) are subject to gift tax. Gift tax is paid by the donor, not the recipient. Note that a tax benefit offered by 529 plans is a 1-time gift that can be made into the account equal to 5 times the current gift tax exclusion, without the donor worrying about having to pay gift tax. Since the current exclusion is $15,000 in 2020, 5 times this amount or $75,000 can be donated as a 1-time gift and not be subject to gift tax.

Which statement is TRUE?

Contributions to both a 529 and Coverdell ESA are not tax deductible Contributions to both Coverdell ESAs and 529 plans are not tax deductible. Earnings build tax-deferred in both. Distributions from both, when used to pay for appropriate educational expenses, are not taxable. Coverdell ESA distributions can be used without limit to pay for all levels of education. 529 plan distributions can only be used without limit to pay for college and higher; distributions to pay for education below the college level are limited to $10,000 per year. High earning individuals cannot open a Coverdell; there is no similar restriction on a 529 plan. Coverdell ESA contributions are limited to $2,000 per child per year; 529 plan contribution limits are set by each state and are much higher.

A high-earning individual can open and contribute to all of the following accounts EXCEPT:

Correct answer A Coverdell ESA B 401(k) C 403(b) D UGMA Account for her niece Custodial accounts opened under either the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA) can be opened by any adult for any minor, with no limitation on the income of the donor in determining whether the account can be opened. High income earners are permitted to contribute to all ERISA plans, Traditional IRAs, SEP and SIMPLE retirement plans, 529 Plans, and 403(b) plans. On the other hand, high-earning individuals are prohibited from opening either a Roth IRA or a Coverdell Education Savings Account.

Which statement is TRUE when comparing UTMA Custodial Accounts to Coverdell Education Savings Accounts(ESAs)?

Earnings in UTMA accounts are subject to Federal income tax while Coverdell ESAs are not subject to Federal income tax Custodial accounts opened under either the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA) can be opened by any adult for any minor, with no limitation on the dollar amount that can be donated into the account. There is no tax deduction for the donor for the contribution and earnings in the account are taxable annually to the minor. Because all of the funds in the account represent "after-tax" dollars, there is no tax liability when funds are withdrawn. Coverdell Education Savings accounts can be opened by any adult for a minor, with annual contributions into the account limited to $2,000. The contribution amount is not deductible. Earnings build tax-deferred; and when distributions commence, as long as they are used to pay for that minor's education expenses, the distribution is not taxable (a major tax benefit). Also note that high earning individuals cannot open Coverdell ESAs.

Which statement is TRUE about HSAs?

HSAs are funded with tax-deductible contributions Health Savings Accounts (HSAs) were first authorized by Congress starting in the beginning of 2004. They are a tax advantaged medical savings account that is owned by the individual. They are established by corporate employers as part of their health insurance plans, and only plans that have a high deductible can set up HSAs for employees. More employers are adopting these high-deductible plans coupled with HSAs as a way of reducing, or slowing the growth of, their health insurance expenses. The HSA permits the employer or employee to make a deductible contribution in 2020 of up to $3,550 for a single individual; or $7,100 for a family; to the account. The contribution amount is indexed for inflation annually. The account is invested in a similar manner to an IRA. It grows tax-deferred and withdrawals to pay for qualified medical expenses are tax-free.

A single mother has 2 children, ages 5 and 9. She earns $150,000 per year and wishes to open Coverdell ESAs for each child to pay for qualified education expenses. Which statement is TRUE?

She is prohibited from opening an account for each child because she earns too much Both Roth IRAs and Coverdell ESAs are not available to high-earning individuals. There is an income phase-out range, above which contributions are prohibited to either of these. For 2020, the top end of the income phase out range for individuals is $110,000 and for couples it is $220,000.

Which of the following is a characteristic of Coverdell ESAs?

Tax free distributions are to be used only for educational purposes Coverdell Education Savings Accounts allow for $2,000 a year to be contributed to pay for a child's education expenses. There is no tax deduction for the contribution and the account grows tax free, as long as the funds are used to pay for school expenses. These are not terribly popular because they are not available to high earners. The funds in the account must start being used at age 18 (but they can be used earlier than this) and the account must be depleted by age 30. Any undepleted funds at age 30 can be transferred to another family member going to school who is also under age 30. If there are unused funds at age 30 that are not transferred, they are taxed.

High-earning individuals can make contributions to:

UGMA Accounts Custodial accounts opened under either the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA) can be opened by any adult for any minor, with no limitation on the income of the donor in determining whether the account can be opened. On the other hand, high-earning individuals are prohibited from opening either a Roth IRA or a Coverdell Education Savings Account.

Which statement is TRUE?

Up to $10,000 in funds in a 529 plan can be used to pay for education below the college level. Whereas funds that are in a 529 plan can be used to pay for higher education expenses, up to $10,000 per year can be used to pay for education below the college level. Also, starting in 2020, up to $10,000 per year can be used to pay off qualified education loans. In contrast, funds in a Coverdell ESA can be used without limit to pay for any "qualifying" educational expense, and these include elementary school, middle school, high school, college and vocational school. Neither a Coverdell ESA nor 529 limit students to education within state borders.

Many years ago, a customer opened a Coverdell ESA for his son, who is now age 16, and a savings account for his daughter, who is now age 18. The 18-year old daughter is entering college and does not have enough money in the savings account to pay for tuition. To pay the tuition bill, the customer:

can change the beneficiary on the Coverdell ESA from the son to the daughter The beneficiary can be changed in a Coverdell Education Savings Account, so the funds from the 16-year old's Coverdell account can be transferred over into an account in the name of the daughter to help pay for the daughter's education costs. There is no approval of the 16-year old son required because the account is controlled by the donor - plus, minors cannot give approval!

A distribution from a Section 529 Plan would be taxable if the beneficiary:

does not go to college Payments from Section 529 plans made to colleges, universities, vocational schools, and any other accredited post secondary education institution are not taxable. Starting in 2018, up to $10,000 per year can be withdrawn to pay for education below the college level, and starting in 2020, up to $10,000 per year can be used to pay off qualified education loans. In addition, refunds made because of death or disability of the beneficiary, or because the beneficiary received a scholarship, are not taxable. Distributions made for any other reason are taxable.

When recommending a 529 plan to a client, the registered representative should inform the customer about the:

fact that the contribution might be deductible at the state level 529 plans are state-sponsored college savings plans. Any dollar limit on 529 plan contributions is set by the state and the contribution may be deductible from state income tax (but not from federal income tax). This is the point that must be disclosed of the choices offered. There are no income phase outs on who can contribute to a 529 plan; the donor retains control of the assets at all times; and an account can be opened for an adult who wants to save for higher education (and the donor and beneficiary can be the same person, so you can open a 529 plan for yourself!).

LGIPs offered by municipal broker-dealers are:

investment vehicles available to local government entities that permit investment of excess funds An LGIP is a "Local Government Investment Pool." It is an investment fund set up under state law that is only offered to local municipal governmental entities in that state. For example, if a town in a state has collected its real estate taxes, but has not yet spent those funds, it can put the balance in that state's LGIP. The LGIP is managed to provide a safe investment return. The MSRB takes the stance that if an LGIP retains a broker-dealer to market its offerings in that state, then it is a municipal fund security subject to MSRB rules. On the other hand, if the LGIP uses its own employees to market itself to local state governmental entities, then it is not subject to MSRB rules.

An uncle opens a Coverdell ESA for his niece and makes deposits over a number of years. When she enters college, the niece withdraws $10,000 from her Coverdell ESA to pay for expenses. The student only uses $9,000 of the funds. The remaining $1,000:

is taxable at ordinary income tax rates to the niece Any monies that are withdrawn from a Coverdell ESA by the beneficiary, that are not used to pay for qualified education expenses, are taxable as ordinary income.

An ABLE account:

is used to pay for the qualified ongoing expenses incurred by a disabled individual ABLE accounts were enacted by Congress in late 2014. ABLE stands for "Achieving a Better Life Experience Act." It allows each state to set up a "municipal fund security" regulated by the MSRB that permits an account to be established to pay for the ongoing expenses of a disabled person. One of the key features of an ABLE account is that accumulated savings do not affect that person's eligibility for other Federal benefits (it used to be the case that having too much in assets would disqualify that person from other Federal benefits such as Medicaid). Up to $15,000 per year (the Federal gift tax exclusion amount) can be contributed to an ABLE account, with no tax deduction. The account grows tax-deferred, and payments to pay for qualified expenses are tax-free. Qualified expenses include medical care, transportation, housing, education, and assistive technology. The account must be established before the disabled individual reaches age 26, and proof that the beneficiary is disabled or blind must be provided. ABLE accounts are permitted under Section 529A of the Internal Revenue Code. Do not confuse these with 529 Plans, which are a municipal fund security to save for education expenses.

Section 529 plans generally permit:

non-taxable distributions to the recipient to pay for higher education Any adult can open a Section 529 account to pay for the higher education expenses of a beneficiary. Starting in 2018, up to $10,000 per year can be withdrawn to pay for education below the college level, and starting in 2020, up to $10,000 per year can be used to pay off qualified education loans. There is no tax deduction for the contribution; earnings build tax-deferred; and distributions to pay qualified higher education expenses are not taxable.

A tax deduction for a contribution to a Coverdell Education Savings Account is:

not permitted Contributions to Coverdell Education Savings Accounts are not tax deductible - no if's, and's, or but's!

ABLE accounts are:

regulated by the MSRB ABLE accounts were enacted by Congress in late 2014. ABLE stands for "Achieving a Better Life Experience Act." It allows each state to set up a "municipal fund security" regulated by the MSRB that permits an account to be established to pay for the ongoing expenses of a disabled person. One of the key features of an ABLE account is that accumulated savings do not affect that person's eligibility for other Federal benefits (it used to be the case that having too much in assets would disqualify that person from other Federal benefits such as Medicaid). Up to $15,000 per year (the Federal gift tax exclusion amount) can be contributed to an ABLE account, with no tax deduction. The account grows tax-deferred, and payments to pay for qualified expenses are tax-free. Qualified expenses include medical care, transportation, housing, education, and assistive technology. The account must be established before the disabled individual reaches age 26, and proof that the beneficiary is disabled or blind must be provided. ABLE accounts are permitted under Section 529A of the Internal Revenue Code. Do not confuse these with 529 Plans, which are a municipal fund security to save for education expenses.

The purpose of an ABLE account is to:

save funds on a tax-deferred basis to pay for the ongoing care of disabled individuals ABLE accounts were enacted by Congress in late 2014. ABLE stands for "Achieving a Better Life Experience Act." It allows each state to set up a "municipal fund security" regulated by the MSRB that permits an account to be established to pay for the ongoing expenses of a disabled person. One of the key features of an ABLE account is that accumulated savings do not affect that person's eligibility for other Federal benefits (it used to be the case that having too much in assets would disqualify that person from other Federal benefits such as Medicaid). Up to $15,000 per year (the Federal gift tax exclusion amount) can be contributed to an ABLE account, with no tax deduction. The account grows tax-deferred, and payments to pay for qualified expenses are tax-free. Qualified expenses include medical care, transportation, housing, education, and assistive technology. The account must be established before the disabled individual reaches age 26, and proof that the beneficiary is disabled or blind must be provided. ABLE accounts are permitted under Section 529A of the Internal Revenue Code. Do not confuse these with 529 Plans, which are a municipal fund security to save for education expenses.

Section 529 plans are established by the:

state