DISTRIBUTIONS
If distributions for a year exceed qualified education expenses, the excess is taxable after basis is recovered proportionately from the entire distribution.
Any amount that is taxable also is subject to a 10% penalty, unless it is a distribution made on account of death, disability, or unless the distribution is equal to or less than the amount of scholarship or other tax-free educational assistance received by the account beneficiary.
NOTE: Penalty-free education distributions cannot be made from qualified retirement plans. Qualified plan participants whose plans permit may want to consider transferring funds to a Coverdell IRA for penalty-free educational distribution.
A taxpayer won't be penalized if funds in the account aren't needed for educational purposes because the beneficiary received a scholarship.
Any remaining balance in a Coverdell IRA must be distributed when the beneficiary attains 30 years of age, and any earnings will then be subject to tax and penalty. However, before the beneficiary reaches age 30, the account balance can be rolled over or transferred tax-free to another Coverdell IRA for the benefit of a member of the family of the old beneficiary.
Qualified withdrawals from a Coverdell IRA include those expenses permitted for 529 plans and also include amounts transferred to a 529 plan.
In any year that an exclusion is claimed for a distribution from an education IRA for a beneficiary, neither a HOPE credit nor a Lifetime Learning credit may be claimed for education expenses all for the same beneficiary. However, the exclusion for distributions from Coverdell IRAs can be waived if the HOPE credit or Lifetime Learning credit would save more tax than the waiver of the exclusion would cost.
For more details, see IRS Publication 970, Tax Benefits for Higher Education (at IRS.gov) or call 800-TAX-FORM (800-829-3676).
Uniform Transfer to Minors Act (UTMA) Custodial Accounts - MICHIGAN***
The Uniform Transfers to Minors Act (UTMA) is a way for children under 18 years old to own stock or other property.
For tax and other reasons, parents, grandparents and others sometimes want to transfer ownership of cash and other financial assets to children who are too young to handle such assets.
This can be
accomplished with a trust, however, an UTMA is an alternative that may be simpler, cheaper and faster than a trust.
Eligibility: Any adult can set up a custodial account for any child under age 18.
Contribution Rules: Although there are no contribution limits, amounts above $13,000 ($26,000 for a married couple filing jointly) will incur federal gift tax.
Contribution Deadline: A custodial account (UTMA) does not have a contribution deadline.
Potential Advantages: Aside from the requirement to hand over “control” of any remaining money to a child at 18 or 21, these accounts are extremely flexible. It’s basically up to the custodian (usually the parent) to determine how to invest the money and when to spend it on the child.
Use of this account can help, however there is no guarantee, that $850 of investment income will be exempt from federal income tax, with another $850 being taxed at the child's tax bracket. The child must be under age 18 at the end of the current tax year.
Potential Disadvantages: The same tax benefit that makes custodial accounts attractive can also make them unattractive. After the first $1,700 in income potentially being sheltered from taxes, excess income is fully taxed at a parent’s marginal tax bracket. This would not occur in a Section 529 plan or a Coverdell ESA.
A custodian must hand over control of the assets to the child at anywhere from age 18 to 21. Once this occurs, parental control ends and the child is not obligated to spend the money on higher education expenses.
Investment Options: Custodial accounts allow typical stock, bond, and mutual fund investments. Due to their custodial and protective nature, they are not permitted ownership of higher risk investments (i.e. stock options, buying on margin).
Tax Benefits: An important misconception about an UTMA is a guarantee that you will not pay income tax on a certain amount of dividends, interest, and gains. Custodial accounts don’t grant this privilege, but simply take advantage of what is already allowed.
Every child under 19 years old (or 24 if a full-time student), who files as part of their parents’ tax return, is allowed a specific amount of “unearned income” at a reduced tax rate. Currently, the first $850 is considered tax-free, and the next $850 is taxed at the child’s bracket (10% for Federal income tax). Any amount above these limits are taxed at the parents’ rate.
The exemption is per child, not per account. Opening a custodial may not make a difference if the child already has a high level of unearned income (e.g. investment income).
Eligible Expenses: Expense that is for the benefit of the child may be paid from the custodial account, at the custodian’s (usually the parent) discretion.
Effect on Federal Financial Aid Eligibility: Custodial accounts are considered an asset of the child and must be reported on a financial aid application for college. Approximately 20% of these assets will be expected to be used towards funding a student’s education in any given year.
Withdrawal Rules: The custodian can initiate a withdrawal for the benefit of the child, when the expenses are for legitimate needs. Withdrawals are not limited to college expenses as they can be used for pre-college educational expenses.
Unused Funds: In most situations, transfer of custodial property must occur when the child turns 18. However, under certain conditions, the UTMA states that the transfer may be delayed past age 18, however no later than the child’s 21st birthday.
Unlike Section 529 plans and Coverdell ESA’s, there’s no ability to transfer the account to another child or change beneficiaries.
DISCLOSURES:
*529 Plans
The State of Michigan, through the Michigan Department of the Treasury offers a 529 Michigan Education Savings Program.
Please read the offering statement and participation agreement and carefully consider the investment objectives, risk and expenses before investing or sending money.
Investments in the 529 plans are subject to market risk and there is no guarantee that funds will be sufficient to cover all college costs.
Investor's home state may only offer favorable tax treatment for investing in a plan offered by such state.
Investor may incur penalties if funds are withdrawn early.
Guarantees and/or payments are based on the claims-paying ability of Issuer and not on the value of the securities within the account.
MEA Financial Services/Paradigm Equities, Inc. does not give tax or legal advice. The comments regarding the law and tax treatment simply reflect our understanding of current interpretations of such laws. Since laws are always subject to interpretation and possible changes, we recommend that you seek the counsel of an attorney, accountant or other qualified tax advisor regarding these matters as it applies to your particular situation.
**Coverdell ESA
Maximum allowable contributions to a Coverdell ESA are subject to Adjusted Gross Income limitations.
Investments in the plans are subject to market risk and there is no guarantee that funds will be sufficient to cover all college costs.
Please read the offering statement and participation agreement and carefully consider the investment objectives, risk and expenses before investing or sending money.
Please read the offering statement and participation agreement and carefully consider the investment objectives, risk and expenses before investing or sending money.
Investments in the 529 plans are subject to market risk and there is no guarantee that funds will be sufficient to cover all college costs.
Investor's home state may only offer favorable tax treatment for investing in a plan offered by such state.
Investor may incur penalties if funds are withdrawn early.
Guarantees and/or payments are based on the claims-paying ability of Issuer and not on the value of the securities within the account.
MEA Financial Services/Paradigm Equities, Inc. does not give tax or legal advice. The comments regarding the law and tax treatment simply reflect our understanding of current interpretations of such laws. Since laws are always subject to interpretation and possible changes, we recommend that you seek the counsel of an attorney, accountant or other qualified tax advisor regarding these matters as it applies to your particular situation.
***UTMA
MEA Financial Services/Paradigm Equities, Inc. does not give tax or legal advice. The comments regarding the law and tax treatment simply reflect our understanding of current interpretations of such laws. Since laws are always subject to interpretation and possible changes, we recommend that you seek the counsel of an attorney, accountant or other qualified tax advisor regarding these matters as it applies to your particular situation.
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