Paul Ferraresi

This is the second installment of the various methods to save for a child’s college education.

Crummey Trust

Plus

 Can invest in wide variety of investment vehicles.

 Child does not gain control at age of majority, although child has right to withdraw contributions when made.

 Trust can have more than one beneficiary.

 Gift qualify for $12,000 gift-tax exclusion.

Minus

 Can be expensive to set up.

 Assets are child’s for financial-aid purposes.

 Beneficiary could exercise his or her withdrawal right over contributions.

 Only trusts for single beneficiary can qualify for GST exclusion for grandchildren.

Standard Brokerage Account in Parents’ Names

Plus

 Maximum investment flexibility.

 Investors avoid layer of fees charges by 529s and Coverdells.

 Parent control assets.

 Keeps assets out of child’s ownership for financial-aid purposes.

 If child doesn’t go to college, fund can be used for any purpose.

Minus

 Capital gains and income are taxed.

 Does not remove assets from parents’ estate for estate and gift-tax purposes.

Retirement Accounts

Plus

 No 10% penalty on IRA withdrawal if used to pay qualified expenses.

 IRA balances are not part of financial-aid calculations.

 Unused funds can be used for retirement.

 Account owners can take a loan from 401(k) plan and pay it back over time..

Minus

 For traditional IRAs, ordinary income tax will be due on full distributions.

 For Roth IRAs, ordinary income tax will be due on the earnings portion of the distribution if withdrawn before owner reaches 59 ½ and has held account less than five years, full distribution is tax-free.

 Withdrawals may be counted as income in financial-aid formulas.

 Account owners may hinder their retirement funding.

Savings Bond

Plus

 Safe.

 Interest exempt from state and local taxes.

 Series EE bonds purchased after 1989 and all Series I bonds allow tax-exempt distributions if used for qualified education expenses and if income limits are met.

 Can buy $30,000 each of I-bonds and EE-bonds a year.

 No penalty if not used for college.

 No account-maintenance fees.

Minus

 Muted returns.

 Income restrictions limit interest exclusion from taxes.

 Only bondholder, his or her spouse, or a dependent is eligible for the interest exclusion. If grandparent holds the bond, he or she can’t claim any interest exclusion unless the grandchild is dependent.

 Interest exclusion may be reduced by other education tax breaks (HOPE Scholarship, Life-time Learning Credit, scholarships, Coverdell withdrawals, Section 529 plan withdrawals) when used in the same tax year.

 Bondholder forfeits three months of interest if redeemed within five years.

 Bond owner must be at least 24 years old.

With all the turmoil in the financial markets many people have voiced their concern about insurance companies. People wonder if insurance companies have similar problems. The truth is that Insurance companies are regulated and backed in a stronger manner than banks. Here is a great article from TheStreet.com written in September. It will educate you and bring some peace to your mind.

After the sudden fall of American International Group (AIG Quote – Cramer on AIG – Stock Picks), policyholders everywhere are asking the same question: How safe is my insurance company?

We all depend on insurance, from health coverage, life insurance, protection for our house and car, to our annuity in retirement. Every facet of our lives involves insurance, and we pay a large amount to make sure we will receive help when we need it.

How can you be sure your insurer is able to meet its claims? If you live in Texas and were affected by Hurricane Ike, aside from the desperate worry over the damage to your property, the news last week about AIG will not have helped.

There are two positive things about insurers. First, they are strictly regulated to ensure companies maintain the ability to meet claims, and this regulation is overseen by state insurance commissioners. Second, in the event an insurer is unable to meet its claims, states have a guaranty arrangement where all insurers would be required to contribute funds. When there is a multi-state life and health-company failure, the National Organization of Life and Health Insurance Guaranty Associations, or NOLHGA, coordinates claims. Similar guaranty associations exist for all insurance types.

So what is different about an insurance company that provides additional comfort? After all, banks are regulated by the FDIC and they fail, and AIG has failed too?

It is important to realize that AIG’s insurance companies are continuing to operate as normal. The insurance companies did not fail; the problems are with the holding company. The insurance companies are considered by the National Association of Insurance Commissioners, or NAIC, to have sufficient liquidity to meet all claims. In fact, the NAIC has set up a special committee of commissioners overseeing AIG to ensure normal operations. Additionally, the NAIC will oversee any sale of an insurance company.

“It will likely be the insurance subsidiaries or their valuable blocks of business and high-quality assets that will be sold in an attempt to return the AIG parent company to a more stable financial position,” NAIC President and Kansas Insurance Commissioner Sandy Praeger said.

The NAIC outlines the regulatory position as operating under conservative accounting rules and mandatory annual CPA audits. Insurers must follow investment regulations and limitations, and there are minimum capital surplus requirements. From a risk perspective, state insurance regulations give insurers the ability to continue to operate normally with greater losses than other parts of the financial sector in down-market cycles. State regulators also perform ongoing financial analysis of insurers and on-site examinations.

According to the NAIC, the entire solvency framework and safety net for policyholders is uniform in every state as evaluated by its Financial Regulation and Accreditation Program. Rating downgrades and drops in share prices do not change an insurer’s ability to pay claims. Ratings issued by TheStreet.com are intended to provide exactly that comfort with the financial-strength rating of the insurance company representing the ability to meet a policyholder’s claim considering various indicators covering capital, reserves, profitability, investments, liquidity and stability.

If an insurance commissioner believes an insurance company is at risk, steps can be taken to protect policyholders. A company can be placed under supervision, a step intended to monitor the company and give it specific targets to meet before the company can continue to operate without oversight. An alternative, in the event of imminent failure, would be to seek a court order to place the company under the control of the commissioner, in which case a manager would normally be appointed to run the company.

There are strict financial guidelines in place to provide policyholders the comfort that insurance companies are acting prudently, state regulators are monitoring the companies to make sure that insurers follow the regulations, and there are actions that a regulator can take to protect the policyholder.

During a disaster like a hurricane, the guaranty funds can kick in if a company fails. NOLHGA President Peter Gallanis said the group has acted in over 60 multi-state insolvencies over the past 25 years, assessing over $4.4 billion on its members to meet policyholder claims. “Current assessments are averaging $25 million per year, a relatively low level considering that we have the capacity for $8 billion,” he said. Policyholders have a preferred status over general creditors, he said.

TheStreet.com Ratings issues financial strength ratings for 4,000 life, health, annuity, and property/casualty insurers. They are available on the Insurers & HMOs Screener. In addition, the Financial Strength Ratings on each of the nation’s 8,600 banks and savings and loans are available at no charge on the Banks & Thrifts Screener.

Gavin Magor
09/23/08 – 10:49 AM EDT

There are a multitude of ways to solve for the funding of a child’s college education. Each method has its pro’s and con’s. Family income, the desired college and tax breaks all have an influence on the track you take. No one method is the only route. You can mix and match to fit your needs. Here is a summary overview to assist in your decision making. I have broken it into two parts so as not to overwhelm you.

529 College-Saving Plan

Plus

 Tax-free asset growth.
 Tax-free distributions for qualified education expenses.
 Some states give tax breaks on contributions or matching grants.
 Can claim HOPE and Lifetime Learning Credits for qualified expenses not paid by plan.
 Donor controls the account.
 Anyone can contribute. No earnings restrictions on donor.
 Can gift up to $60,000 a year per child without triggering gift tax, if election made.
 Account owner can change beneficiary to another member of the family.
 If owner is a parent or dependent student, financial aid will only count 5.6% in the family contribution formula.
 Account owner can reacquire funds.
 Some states offer credit protection.
 Federal bankruptcy protection, with limits.

(Account owner can reacquire funds.)

Minus

 Limited investment options.
 Layer of fees adds to investor’s expenses.
 States must have a cap on account size or contribution amounts.
 States can change features of plans and place savings with new managers.
 Account owners can only invest cash, not appreciated securities.
 Nonqualified withdrawals are taxed as income and may incur 10% penalty; also counts as income for financial aid.
 Plan may be tapped by Medicaid if account owners needs nursing-home care and does not have other funds available.
 Not all states have protections against account owner’s creditors.

529 Prepaid Tuitions

Plus

 Prepaid tuition credits lock in future tuition cost at today’s rates.
 Benefits are federally tax-exempt if used for qualified expenses.
 Some states give tax breaks for contributions.
 No income restrictions on donor.
 No investment risk, unless the state mismanages the funds.

Minus

 Fees may apply.
 Limited number of schools participate.
 May have a limited enrollment and contribution period.
 Account owner or beneficiary is generally required to be resident of state offering plan.
 If child attends out-of-plan school, some costs may not be covered.
 Room and board usually not covered.
 If owner terminates plan, state usually only returns original contribution and levies cancellation fees.
 States may encounter shortfall risk.
 Ability to change beneficiary may be limited.

Coverdell Education Saving Account

Plus

 Tax-free asset growth.
 Tax-free distributions for qualified education expenses.
 Can claim HOPE and Lifetime Learning Credits for qualified expenses not paid by Coverdell account (until 2011).
 Great flexibility of investment choice.
 Expenses may be lower than that of some 529 plans.
 If owner is a parent, financial aid will only count 5.6% in the family contribution formula.
 Funds can be used for primary and secondary school costs (until 2011).

Minus

 The Pension Protection Act of 2006 did not make features permanent. Contributions will revert to $500 per year starting in 2011, and funds won’t be able to be used for elementary and secondary school costs.
 Contributors face earnings restrictions.
 Total contributions may not exceed $2,000 a year per beneficiary.
 No state-income tax deduction for contributions.
 Nonqualified withdrawals are taxed as income and incur 10% penalty.
 Beneficiary takes control of the account at age of majority.
 Beneficiaries must be under age 18 when contributions are made.
 Assets must be distributed by age 30 or earnings are taxed as ordinary income plus a 10% penalty.
 Account owners can only invest cash, not appreciated securities.

UTMA/UGMA

Plus

 Easy to open.
 Less expensive than setting up a trust.
 Can invest in wide variety of investment vehicles.
 Donor can gift appreciated securities and cash.

Minus

 Beneficiary takes control of money at statutory age (usually age 21 for gift accounts).
 Accounts must be terminated once the child reaches statutory age.
 Income subject to “kiddie tax.” Parent responsible for making sure tax return is filed on the child’s behalf.
 If parent is donor and custodian of the account and dies, the UTMA/UGMA becomes part of parent’s taxable estate.
 Because the child owns the account, up to 20% of this money will be counted toward the family contribution when determining financial-aide eligibility.
 Gifts made to UTMA/UGMA accounts are irrevocable.
 No ability to change beneficiary.

2503(c) Minor’s Trust

Plus

 Can invest in wide variety of investment vehicles.
 Trustee can spend money on behalf of minor until he or she reaches age 21.
 Can contribute an unlimited amount, but gifts in excess of $12,000 (most likely $13,000 for 2009) per year per beneficiary may be subject to gift tax.

Minus

 Can be expensive to set up.
 Assets are child’s for financial aid purposes.
 Income taxed at trust rates, which are often higher than individual rates.
 Child gains control at age of 21 unless he or she give up privilege.
 May decrease chances of receiving financial aid.
 Gift to trust are irrevocable.
 Only one individual can be the beneficiary (so there’s no ability to change beneficiary).

Planning for long term care is not a fun subject to work on. None the less if you are looking at yourself or, parents living past age 85, then planning should start around age 40. There are many options to solve this looming crisis (many times written about in this blog), but, the usual solution is to wait until it happens. If you wait, then, there will be few options available and your family wealth is wiped out needlessly.

The chart below is provided to begin an educational process for you. Get professional help, plan early, implement your plan. If not… will you be like the “grasshopper” or the “ant”? Ah yes, discipline or regret…

Paying for Lifetime Community Care

Click on image below to see full-size:

(From Journal of Financial Planning, February 2008)

Most people view financial planning as something that is only about the “numbers.” In reality, the true essence of financial planning, with our clients, is in planning their legacy. It is the knowledge and wisdom they pass down to their families that counts, not the money.

There have been dramatic changes in a person’s life expectancy over the existence of “mankind.” Here are some interesting facts as you plan your “legacy.”

• When man first walked the earth the average person lived about 18 years.

• At 1000 AD life expectancy increased to 25 years.

• At 2000 AD life expectancy increased to 77 years.

• Today, a female that lives to age 5 is expected to live to age 100.

(The fastest growing segment of Americans are those living past 100)

• Mortality experts predict for a female born today there is no reason why she will not live to 137 years or more.

• Two thirds (66%) of all the people that have lived past age 65 are alive today.

These lifestyle changes are transforming retirement.

Webster’s dictionary definition of retirement is… to disappear… go away…withdraw.

Our new view of retirement is … connected, reinvent oneself and freedom.

When we do Legacy planning with our clients we center on many topics. Here are a few…

The Four Pillars:

(1) What are the valuable life lessons you want to pass on?

(2) What are your instructions and wishes to be fulfilled?

(3) Are there personal possessions of emotional value that you want to pass down? Why do they have an emotional value for you?

(4) What are the financial assets or real estate you want to pass on to family members or charitable organizations?

Many families do not want to engage in these conversations for fear of conflict, discomfort or being upset. I organize the family meeting as a fun time.

There are ground rules for each meeting. Most important is that everyone’s ideas are correct. There is no “alpha” child. Although each child feels they are the “special child” to mom and dad and deserve the majority of inheritance… each child is equal.

I encourage everyone to be honest, be an avid listener and explain their thoughts in an easy progression. We want to talk about the 4 Pillars before an illness sets in with any family member.

From there we talk about the values and the life lessons that are important to each person. We then create Videos, Scrapbooks or DVD’s.

One of the best ways to start this process is to have family vacations with a purpose.

On these family vacations our clients are encouraged to concentrate on at least one area within each of the quadrant living model.

This whole legacy planning should be centered around the love and respect of the family.

La familia e molto importante!

If you want more information on how we help our clients in this area please contact us.