I have written this article for information purposes, and I hope you learn something from it. Though I would like to state it is current and up to date, in all candor, I can't. In most cases, the concepts are relatively accurate (except for obviously old and dated materials, primarily related to taxes). You should confer with your own lawyer about issues that affect you and your family.
There is a risk in introducing new wealth transfer concepts, because every tax benefit Congress gives us seems to be taken away before we begin using the new legislation. With this qualification in mind, however, I think we ought to consider two techniques in shifting income, and that we should use them if they fit a need:
Section 529 Plans: QSTPs (Qualified State Tuition Plans)
Let me begin with the ultimate benefit of a Section 529 Plan: wealth transfer by gift, and no income taxes on growth. Here’s what can be done:
· Grandparent (call him the “Account Owner”) decides to gift $50,000 to a Qualified State Tuition Plan, for the benefit of Grandchild (we’ll call him “Lucky”).
· Grandparent pays no gift tax, because he can use the annual exclusion of $14,000 for the year of the gift, and amortize the remainder of the gift over a five year period.
· If Grandparent dies before Lucky begins college, another Account Owner takes over (probably one of Lucky’s parents). The amount gifted is not part of Grandparent’s estate.
· Suppose the account doubles in value by the time Lucky begins college. There are no income taxes paid on the growth, even when the money is withdrawn.
· If Lucky misbehaves, the Account Owner can change the beneficiary.
· If Lucky decides to go to college (or other institution of higher learning, such as Vo Tech), the money can be used for tuition, supplies, books, room, board, equipment expense and the like. The Account Owner determines when, how much, and for what purpose the money is to be used.
If there is a risk of incurring a “kiddie” tax, for children under age 18, then QSTPs should be considered as a means of avoiding the kiddie tax. Keep in mind that income is not taxed through these plans (unless, of course, the money is used for something other than higher education).
Each state has its own plan, and although I may not live in Rhode Island (I live in Oklahoma), I may establish a QSTP in another state, with the knowledge that my beneficiary (Lucky) will go to college in Ada, Oklahoma (or Austin, Texas, or South Bend, Indiana). If I establish a Rhode Island QSTP, I will lose control over how my investments are managed – each state has a different set of managers. Oklahoma’s plan is currently administered by TIAA-CREF.
These tax benefits are part of EGTRRA, which will “sunset” in 2011 (the nature of the Sunset Rules is mentioned elsewhere). If you are interested in learning more about your state’s plan, you might visit www.collegesavings.org, which is rich in details not discussed in this article.
QSTPs are different from Coverdell Education Savings Plans (formerly Educational IRAs), not only with respect to the amount that can be contributed (Coverdells are limited to $2,000 a year; the caps on QSTP contributions depend on the states where the plans are established, but are much, much higher than Coverdells), but also with respect to investment control (the Account Owners cannot control investments using QSTPs, whereas the donors in Coverdells have about the same control they would have under a conventional IRA).
Section 2503(c) Trusts
I believe everyone knows that the gift of a future interest does not qualify for the annual gift tax exclusion. To qualify for the exclusion, the gift must be one of a present interest. Ergo (don’t you love that word?), we are permitted (if we do it right) to create a present interest trust, which might defer benefits to young children until a later age. In essence, if Grandparent wants to shift wealth to grandchild, but doesn’t want the grandchild to use the $14,000 gift to buy a wide-screen TV, the grandparent can create a Section 2503(c) trust (which is an irrevocable trust). Here’s what happens:
Gift is made to the trustee, who is directed to distribute income each year, to a beneficiary, until the beneficiary reaches age 21. If the beneficiary doesn’t object in writing a month before reaching age 21, the term of the trust is extended until age 30.
Using this scenario, the grantor moves both property and income to a related party, without the restrictions of UTMA or UGMA. The grantor can direct the trustee (who should be someone other than the grantor) to make discretionary distributions, but the amount of the gift, for purposes of the annual exclusion, will be less than 100%. The computations are complicated, much as the ones dealing with GRITS, GRATS, GRUTS, and the formulas can be found in tax services, such as RIA’s Estate Planning Resources
Section 2503(c) trusts have their place in estate planning, but with the advent of QSTPs, most gifts to children will probably be made through a QSTP.
©2014 James H. Beauchamp
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