opening account for niece..advice

a while ago i opened an iowa state 529 for a niece. from what i recall all 529s are not at all equal and iowa was a good choice. what i didn't know was that it would be counted as college aid. not so great since her family is broke.

not to mention it's kind of inflexible. has to be used for a certain (but wide i'm told) list of schools.

the big thing it has going for it is tax deferred growth (if used for education).

now for my other niece i'm considering just setting up an account. more flexible in terms of investment also can be used for anything without penalty.

i was told by the vanguard rep i could do a 529, or custodial, or just open another account in my name but for her.

he didn't know too much about how a custodial account would differ in terms of taxes.

he told me the custodial would tax the minor at a lower rate up until $1,800 in profits. after that her parents would get taxed and at higher rate. in reality this account will never make that much since we are just planning to start with $250.

her parent are in a lower bracket for sure then me.

guess i'm just looking for general advice on my options.

much thanks.

Reply to
cporro
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You're doing the right thing by getting better information now. Be careful about what anyone tells you, even me, even here. This is an unpaid forum and while most of us here try our best to give good counsel you must keep in mind that the particulars of the individual situation will ultimately drive what works best for you.

First, the 529 account for your niece shouldn't be a problem for her as far as aid goes. 520s are consider owned by the person who set them up - this should be YOU! Unless you named someone else as custodian or trustee. So when she applies for financial aid they shouldn't even KNOW about this account or count it against her. Remember, this is YOUR money until you actually dole it out to her - you could elect to change the beneficiary at any time at which point the money wouldn't be available to her anymore.

Second - be very, very careful in setting up a regular custodial account for her or any other minor. These are generally referred to as UGMA or UTMA accounts - Uniform Gift/Trust for Minor Accounts. All the money put into these belong to the child, not you - you can't take it back and you cannot control what is done with it once the child reaches the age of majority. That age varies a bit from state to state but is generally between 18 and

  1. So once your niece hits 18 all the money in that account belongs to her and she do with it whatever she wants - we sometimes refer to this and the Harvard vs. Harley dilemma.

The big advantage to the 529 accounts is that the money put into them grows tax deferred AND if taken out and used for qualifying expenses the growth is ultimately free of income tax.

The big disadvantage to the 529 accounts is that if the money is taken out later and NOT used for qualifying expenses then you get hit with not only taxes on the earnings, but you get to pay a penalty as well.

So you have to weight the benefits of tax deferred, and possibly tax free, growth with the possibility of taxes and penalties if the money is not used as originally intended. Keep in mind that you can change beneficiaries later. This helps is your first niece turns out to not need or deserve the money but another family member does.

Most of the time, for non-direct family members who want to help with educational expenses I suggest they consider a simple retail account. This is funded with after tax money - just like the 529s are. BUT it is YOUR money - you can name the niece as beneficiary if you die, so she'll get it if something terrible happens to you. Otherwise it is YOUR money and you can dole it out as you please.

In fact, when it is time for her to go to school you COULD actually gift her some of the investments. The gift value would be at your cost basis so that when she sells them to pay for school the gains would be taxed to her. If her bracket is low enough she could may even be exempt from capital gains tax (assuming we don't get any major changes in those laws between now and then).

Good luck, Gene E. Utterback, EA, RFC, ABA

Reply to
Gene E. Utterback, EA, RFC, AB

right. 18+ years of growth somewhere...or if done poorly 18+ years of oops.

Be careful

true. i usually try and get info from varied sources.

i'm the custodian. here is something from vanguards site. since i'm not her parent the 529 should not be considered when determining financial aid. as you said. good.

  • Student assets. Custodial accounts (under the Uniform Gifts to Minors Act or Uniform Transfers to Minors Act?UGMAs/UTMAs) are considered the student's assets. Assets transferred from an UGMA/UTMA account to a 529 college savings plan remain the student's property. In addition, a transfer from an UGMA/UTMA account involves selling the assets, so any profits could be taxable. * Parental assets. A 529 college savings plan or education savings account funded by a parent is considered the parent's asset even if it names the student as beneficiary. Parents' mutual funds are also counted as parental assets. A parent's retirement assets?Roth or traditional IRAs and employer-sponsored retirement plans?aren't counted in financial aid calculations. However, distributions from a Roth IRA are considered income in calculating the following year's expected family contribution. * Other assets. Grandparents, other relatives outside the immediate family, and friends can hold 529 plan accounts. The assets aren't counted in financial aid calculations because they aren't owned by the student or the parents.
 So

i didn't know that. i thought i was stuck with her. and who knows what she will be like in 16 years. now i wonder if we could split it between her and her sister or another niece. we didn't expect anyone else to have kids and they proved us wrong. so that first niece got a bit much.

i saw that. irretractable. and 21 is too young imo. i was thinking 30.

yes. income tax at i assume my rate and a 10% i think. ouch

from vangard:

Earnings on nonqualified withdrawals may be subject to federal income tax and a 10% federal penalty tax, as well as state and local income taxes. The availability of tax or other benefits may be contingent on meeting other requirements.

retail account? what's that?

so she would be taxed on the value i initially payed and her tax bracket?

thx, that was helpful.

also found vanguard has a nice summery of options for college savings.

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btw, did you ever check out the vast difference from state to state on the 529s?

Reply to
chris porro

If it's the Iowa UPromise 529 program, it is a good choice.

529 assets are not generally considered an asset of the child, but rather an asset of the owner (usually the parent, but it could be the grandparent or uncle or whatever). Assets which belong to the child are usually expected to be used to a much greater extent than assets of the parent. Assets of someone other than the parent are not necessarily considered at all.

That said, the "counts for college financial aid" discussions usually center on what the federal government lists on their standardized application, the FAFSA but that doesn't necessarily mean that private aid will follow those guidelines. Even if FAFSA doesn't count something, private aid might.

529s can generally be used for any eligible postsecondary school in the United States and many abroad, too.

There have been many "prepaid tuition" plans offered by states which specifically guaranteed that the mone put in would pay for tuition at state schools in particular, but if you wanted to prepay for them and then the kid went to another school, you'd get to transfer the value of the savings elsewhere, but not necessarily have had that value grow as fast as you'd have liked, nor necessarily as fast as the costs of education elsewhere would go.

These days, though, most folks are going for regular 529s where you invest the money, and it grows and you just watch it the way you would watch an employer-provied 401k - it grows at whatever rate the investments therein grow -- which doesn't have anything necessarily to do with the rate at which tuitions go up.

Tax *free* for education. That's huge. See the details that Gene provided in his reply.

See Gene's warnings about custodial accounts. There aren't many circumstances where I can see recommending them. Yours certainly don't sound like they'd be appropriate.

[Gene's excellent-as-usual advice snipped]

You may want to consider having a trust be the TOD beneficiary of that money in the event of your death. If it's intended for the kid for college, the trust may specify that - and if the kid doesn't use it for college, the trust may sit on the money until the kid reaches some specific age, or it may pay out to someone or something else (ie. charity, etc).

One word of warning on this, though - if it's a substantial capital gain, and a substantial bit of money - you need to be careful if the assets are sold during a year which you will be reporting income for aid calculations. Those capital gains are income - and if the investment are gifted to and then sold by the niece, that income is reported on the *niece's* taxes -- and financial aid applications.

One more thing to think about - especially if you keep the money in your own name rather than gift to a 529 or directly to the niece. You are allowed to make cash gifts of up to $13,000 per recipient per year before you have to start paying gift taxes. If, however, you pay the tuition directly to the school in question, the gift is not taxable at all. The payment has to go directly to the school - you can't give the niece the cash and tell her to pay the tuition, else you are subject to the annual exclusion limit and potentially additional gift taxes. But you can pay the school itself directly and there are no gift taxes.

If you aren't already maxing out your Roth, you might consider doing that - and if the time comes that you want to help the kids out with school, you may take your Roth contributions out tax and penalty free and make gift-tax-free payments directly to the schools. (Taking out the growth of the Roth contributions may be a little bit more problematic, depending on a variety of factors, but worst case, you take out the contributions and leave the growth to keep growing...)

Re: the gift tax issues, see IRS Pub 950:

The Direct-sold Iowa plan - Upromise and Vanguard:

And, yes, it's a good one, with low expenses.

Be wary of the *advisor*-sold plans - Iowa's and everyone else's. Even Iowa's advisor plan - which has excellent low cost index funds and ETFs - hits you with either absurd ongoing fees of an extra 1%/yr (C class) or with an up-front "sales charge" of either 3.75% or 5.5% depending on the investment selected. That charge goes in the broker's pocket. If that broker is providing you a lot of valuable help and advice, it may be worth paying him that money. But it's optional and if you're talking about a substantial amount of money - suppose you were putting in a few thousand/yr - that adds up pretty damned fast. If you just need some advice about setting this up in the first place, consider paying a fee-only planner, perhaps even by the hour, a one time payment for planning and advice - and then invest in the more cost-effective direct-sold plan (which that fee-only advisor is likely to recommend) and you may come out way ahead.

(Seriously - they're charging 5.5% up front to put people into Vanguard's total stock market ETF - and on top of that, the ongoing annual expenses are 0.72% -- only 0.07 of which are the ETFs actual expense ratio. According to the plan's documentation. As compared to the direct plan where you pay no up-front loads, and the annual ongoing asset-based fees are a flat 0.50%.)

Reply to
BreadWithSpam

Another reason not to use custodial accounts. Some folks are transferring custodial assets into 529s because they already had those custodial accounts. They're looking for something better to do with the money and they're not allowed to just take it back and put it into a 529 of their own.

If the Roth is the parent's or the kid's. If the Roth is your's, no problem. See my other note re this.

If you are the owner of the 529 (and she's the beneficiary), YOU control where it goes. If you want to open another 529 with another niece - or your own kid, etc - as the beneficiary, you may transfer some or all of the money from the existing 529 into the new one. The niece is not in control of that money - you are.

See my other note re: trusts as beneficiaries if you keep assets in your own name that you're planning on giving the kid.

Regular taxable account in your own name. Same as you'd open for yourself. You are allowed to open as many brokerage accounts as you like. If you want to open one to keep assets separate from other assets because they are for a specific purpose, there's nothing stopping you. And each account may usually be allowed to have its own set of designated beneficiaries who get the assets when you die if you like, avoiding probate and hassle. And you can transfer assets into and out of those accounts to your heart's content.

When you make a gift of appreciated assets to someone while you are alive (as opposed to them getting those assets after you die), the recipient of the gift keeps your costs basis. If you paid, say, $1,000 for some stock and it went up in value to $10,000, then you give the stock - as stock (rather than selling it and giving cash) - the recipient now has $10,000 worth of stock with *your* $1,000 basis. And if the recipient then sells that stock, the $9000 in cap-gains are income that the recipient owns and on which he or she may pay cap-gains taxes.

Be careful if you're gifting a large amount of stock - if you give above the annual gift-tax exclusion amount, you may eat into your lifetime gift exclusion and/or eventually have to pay gift taxes.

Reply to
BreadWithSpam

SNIPPED

Essentially there are two kinds of investment accounts - retirement and retail. The advantage to a retirement account is the money can go in on a tax advantaged basis and can grow tax deferred and may even come out tax free. BUT money that goes in tax advantaged up front comes out as ordinary income - essentially you defer the tax until later. For parents this may not be a bad thing since they can get out of the premature distribution penalty for monies spent on qualifying tuition. For other family member, this exception does not apply.

A retail account is a nonretirement account. It is funded with after tax dollars and earnins are taxed as they are earned and reported. The advantage here is that gains usually get taxed at favorable long term rates. This disadvantages include no tax break for putting money in AND having to pay taxes on an "as you go" basis.

Not quite - she would pay tax on the gain which would be calculated on the difference between what you paid for the investment and what she sold it for.

Let's assume that you bought a block of stock in XYZ company for $1,000 today. In 15 years when she needs the money let's assume that its worth $11,000. For the purpose of simplicity we'll ignore dividends and other things like splits and such. Let's also assume that YOU are in the top tax bracket - so you'll pay captal gains at 15% AND likely be subject to AMT, while she is in the 10% bracket. Let's also assume that her parents are in the 15% bracket.

There are two ways to get money in her pocket -

Option 1 - you sell the investment, realize a $10,000 gain, pay $2,600 iu tax and give her the reamining $7,400. NOTE, I used 26% as the tax rate because I believe that is the AMT rate.

Option 2 - you GIVE her the stock, she sells it and realizes the same $10,000 gain. However, because she is in the lowest tax bracket she has a long term capital gain rate of ZERO Percent so she pays no tax. Instead she gets the full $10,000 to use on tuition.

There is a bit more to it that just this, but this gives you an idea of the concept. You'll need to factor in your rate, her rate, perhaps her parent's rate, let's not forget the kidde tax, and gaze into your crystal ball and try to figure out what the tax rules will be some 16 years into the future.

Good luck, Gene E. Utterback, EA, RFC, ABA

Reply to
Gene E. Utterback, EA, RFC, AB

I don't begin to understand the tax issues, but from what you say, it seems that the type of product included in the plan and where it is purchased is just as important if not more important than the choice of type of plan and its tax implications. At the very least, the purchaser would be well advised to run the fees and expenses numbers at the same time as calculating the tax benefits.

Reply to
Don

The point here is that I was comparing the same state's 529 plan against itself - there are two ways to access that plan - either you do it by going directly to the plan - or you go through an "advisor" (which is what folks often call brokers and salespeople). The tax issues are identical - in both cases it's a 529 plan - growth tax deferred and if proceeds used to pay for education, growth withdrawals are tax free.

Sorry if that was unclear.

I am curious which version of the plan the original poster is in - I'm hoping it's the low-cost direct version because if it's the very expensive "advisor" version, he's paying a lot of money for advice he's not apparently getting.

Reply to
BreadWithSpam

Uninformed people might be inclined to focus on tax issues alone and be unaware of the difference in cost between the direct version and the "advisor" version, or even be unaware of the investment product that is ncluded in the plan. The rule should be: Don't let the tax tail wag the investment dog.

Reply to
Don

For what it's worth, if someone's already working with a full-service broker and paying them loads and commissions and such and they ask the broker about saving for college, it's nice that the broker can offer them 529s within their existing relationship. If they couldn't, the brokers may have financial incentives to keep them out of 529s which may in many cases be the very best way that the clients should be saving for college.

On the other hand, I'm pretty skeptical of the idea that those brokers are generally really earning those outrageous fees that the advisor versions of both 529s and, for example, normal load based mutual funds cost the clients.

Either way, you're right - the taxes are only *one* of many considerations that folks should be aware of. Expenses are a major issue as well - and, of course, performance of the underlying investments in the first place.

Complicating the matter here, though, is that we're also talking about potential gift tax issues, and - especially tricky - possible control issues (the original poster wanted to save for his niece).

I hope the OP has gotten something out of all this - please let us know what you end up doing!

Reply to
BreadWithSpam

Keep in mind that under current law, this sale would be taxed on the parent's tax return, not the kid's, until age 23 - if the kid is in college and not covering at least half of her expenses. That new wrinkle to the kiddie tax makes UGMA/UTMA accounts less appealing.

As someone mentioned though, the tax rules and financial aid formulas

15+ years from now are the ones to be concerned with, and we can't know those. I work under the assumption that 529 plan assets will remain tax-free, but could be counted towards any financial aid (either on FAFSA or per school policy). It makes sense that it will end up that way, you don't need subsidized financial aid if you have $500k in a 529 plan.

And if you assume "tax free"...well that's hard to beat, if you're using a low-cost plan and comparing it to say index funds in a taxable account. Over long time periods anyway.

Simplicity is another big plus...filling out one form sets up an account that can be funded by multiple people, benefiting one kid, specifically for education, but with flexibility to make changes. That's pretty hard to accomplish via other means. And that 10% penalty isn't really all that bad - if there's no other beneficiary to transfer the money to, and you just pull the funds, the penalty is on income only. 20 years of tax deferral might be enough to balance out most of that penalty.

-Tad

Reply to
Tad Borek

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