The Jacobs Financial Group

Having Trouble Coming Up With Your Grandkid’s Graduation Gift? Try the Gift of Tax-Advantaged Savings

It’s a few short weeks until cap and gown season begins, and for grandparents hoping to do something nice for their grandkids and something sensible for their estate, there are several options to explore.

Roth IRAs: The Roth option is a good one if you want to help them start a retirement fund of their own or if you want them to inherit a Roth where they can make tax-free withdrawals after your death.

Roth IRAs aren’t a useful alternative for very young kids because the rules state that all Roth holders have to have earned income to be able to make contributions. If they fit that description – as many kids working in high school do – either their parents or guardians can open the account and grandparents can make contributions to match the percentage of earnings kids put in their Roth IRA. Grandparents simply match that contribution.

Also, if you have a Roth IRA, you can benefit your grandchildren by naming them as your primary beneficiaries, and when they inherit it, they’ll be able to make tax-free withdrawals for a home, an education or any other purpose.

Parents or grandparents may want to consider setting up and funding a Roth IRA for their children or grandchildren as soon as the children or grandchildren have enough earned income from part-time or summer jobs. This will ensure that the five-year requirement is met when the individual for whom the Roth IRA is established is ready to make a withdrawal to buy a home, for example.

529 Plans: Another great tool for grandparents is the 529 college savings plan. Grandparents can fill out a plan enrollment form designating a grandchild as beneficiary, select the investments from the plan’s options, and make future contributions either by check or by automatic contribution. It’s also fine for grandparents to make their contributions directly to a 529 account already owned by the grandchild’s parents.

As a refresher, 529 college savings plans – named for the federal law that created them in 1996 – allows a parent to open a tax-deferred college savings plan with as little as $25 to start in some states. A 529 college savings plan is not the same thing as a 529 prepaid college tuition plan. Prepaid tuition plans are just that – tax-deferred savings plans that allow you to save for tuition for in-state schools (though some plans allow you to transfer out a portion of those assets to out-of-state schools). Also, it’s important to note that prepaid tuition plans are not an automatic guarantee a student will get into that college.

Since 2006, withdrawals from 529 plans have been permanently tax-free. In some states, contributions may also be deductible on state tax returns. All 50 states now have 529 plans college savings plans, and a majority of them provides additional incentives, such as a state-tax deduction to in-state residents who invest in their respective plan.

It’s a good idea to have your financial adviser or your financial professional help you sort through the details of various state plans. There are various services – including Morningstar Inc. – that now rank the offerings of each state’s plan. www.SavingforCollege.com and www.FinAid.org are leading sites to help educate you in how these plans work.

Grandparents can treat their contribution as complete gifts, which means they can apply the $12,000 per year gift tax annual exclusion or an accelerated contribution of up to $60,000, with a special five-year, gift-spreading election. Check with your tax adviser first.

Another great benefit is that a 529 plan owned by grandparents should not affect the grandchild’s eligibility to receive federal financial aid because a grandparent’s assets are not reportable on the free application for federal student aid, or FAFSA, and the tax-free withdrawals from a grandparent-owned 529 plan are not counted as student income or student resources.

Coverdell Education Savings Accounts: For grandchildren heading to private school who are under the age of 18, most grandparents – check your eligibility with a tax professional first – can contribute up to 2,000 dollars annually per grandchild to a Coverdale Educational Savings Account. Coverdell earnings accumulate free of federal income taxes, and can be taken to pay for private elementary, secondary or college. Yet, your income is a factor. You can make a Coverdell contribution as long as your modified adjusted gross income is between 95,000 and 110,000 dollars if you’re single or between 190,000 and 220,000 dollars if you’re a married and filing jointly. Yet, if you exceed either of these requirements, you can ask the parent of the adult child to open up the account and make the contribution, though you will have to give up control over the account.

Make a direct gift of your grandchild’s tuition: Under current tax law, you can make gifts of any amount to cover your grandchild’s tuition. Yet, you’re going to need to pay the college directly and you need to be aware that it won’t dent your federal estate tax exemption (3.5 million dollars in 2009), but it will cut the overall amount of your taxable estate. You can, however, go ahead and make additional gifts per grandchild of $13,000 to help with other college expenses.

March 2010 — This column is produced and is provided by The Jacobs Financial Group. (03-09)

Is Your Child Headed To College Next Fall? It’s Time for Both of You to Take a Crash Course on Borrowing and Spending

Even if you’ve planned relatively well for your future college student’s expenses, the credit crunch and downturn in investment income for colleges have changed the game for financial aid at many schools. That means both parents and students need to approach the college financial aid scene with unprecedented caution.

Harvard University, the world’s richest school, announced in February 2009 that it was slashing 25 percent of its investment staff after its $36.9 billion endowment lost 22 percent of its value in the previous four months and could decline as much as 30 percent by the end of June. In two separate surveys released in January 2009, the Commonfund Institute and TIAA-CREF, in a survey done for the National Association of College and University Business Officers, reported that college endowments fell on average 23 percent in the five months ended Nov. 30, 2008.

Why is this important? It’s true that endowments at schools of all sizes mostly pay for faculty and facilities. But they also provide both grants and scholarships for talented students who need them and have been under significantly more pressure to do so. When students have a tougher time finding lower-cost school financing, the demand for scholarship and grant funding goes sky-high. In many cases, students are forced down the borrowing chain to increasingly risky loan options.

The private student loan sector has also been hit by reports of questionable practices in the last two years. In December 2008, New York Attorney General Andrew M. Cuomo reached an agreement with the College Board – the developer and administrator of the SAT and AP – to stop discounting products and services in exchange for a ranking on colleges’ preferred lenders list. The College Board will now invest $675,000 to develop a set of tools to help financial aid administrators to help students and parents compare student loan offers and identify the lowest-cost loan options.

What can you do? One of the best starting points is a meeting with a financial professional with specific expertise in planning for college and financial aid options. The smartest thing is to work with a planner when kids are young to amass the right amount of savings for college, but it makes good sense for both parents and students to meet with a planner before school starts to underscore the complete list of financial issues the student will face. These include:

Planning alternatives for financial aid shortfalls: Over the past few years, colleges have not been able to offer adequate amounts of funding through Perkins, Stafford and Plus federal education loans, and private student loans through banks have closed up with the credit crunch. For students already admitted at schools for their freshman year in the fall, financial aid letters will start going out this month.

Here’s the catch – many college students get in trouble with debt because they are unaware that many for-profit companies advertising access to federal loans pull their financing from private sources that cost the borrower far more than actual federal loans would. The ability to plan for college well in advance and work with an expert to sift through proper loan alternatives can make the difference between an affordable debt load when a student graduates and potential bankruptcy.

Setting a budget as early as possible for basic expenses: Until the student gets to school it will be tough to tell what actual expenses will be, but it won’t hurt to set a tentative budget that involves taking full account of the student’s savings, the parents’ (and possibly the grandparents’) contribution to everyday expenses and any planned income from work-study or other sources. For a template of a budget written specifically for college students, go to: http://www.aie.org/Calculators/budgetworksheetinschool.cfm

Start managing credit and debit cards before school starts: The time to start managing credit and bank accounts isn’t freshman year. While a teenager won’t build a credit history as an authorized user on a parent’s card, it’s good to get a little practice using it under a parent’s watchful eye. When a child goes on to college, the challenge will be looking for the best credit card offer amongst many and managing that credit responsibly. This is another good reason for both parent and student to meet with a financial planner ahead of school to discuss proper credit card usage and monitoring of a student’s fledgling credit score.

March 2010 — This column is produced and is provided by The Jacobs Financial Group. (03-09)

Always Have a Plan for Leftover 529 Plan Money

With the high cost of education, it’s hard to envision that there might be money left over, but it does happen. Kids get scholarships; they might finish early; sometimes they quit school never to return.

In the case of 529 college savings plans, it’s particularly important to have a backup plan for the possibility of leftover funds, not only to support another family member’s educational goals, but as a potential addition to your estate planning.

As a refresher, a 529 college savings plans – named for the federal law that created them in 1996 – allow a parent to open a tax-deferred college savings plan with as little as $25 to start in some states. You should know that a 529 college savings plan is NOT the same thing as a 529 prepaid college tuition plan. Prepaid tuition plans are just that – tax-deferred savings plans that allow you to save for tuition for in-state schools [though some plans allow you to transfer out a portion of those assets to out-of-state schools]. Also, it’s important to note that prepaid tuition plans are not an automatic guarantee a student will get into that college.

As part of sweeping pension reform signed into law by President Bush in 2006, withdrawals from 529 plans are now permanently tax-free. In some states, contributions may also be deductible on state tax returns. All 50 states now have 529 plans college savings plans, and a majority of them provides additional incentives, such as a state-tax deduction to in-state residents who invest in their respective plan.

It’s a good idea to have your financial adviser help you sort through the details of various state plans. There are various services – including Morningstar Inc. – that now rank the offerings of each state’s plan. SavingforCollege.com and finaid.org are leading sites to help educate you in how these plans work.

So, if you’ve made all these moves, how should you handle surplus 529 funds? There are a few options:

Change the beneficiary: If Student #1 doesn’t spend out the funds, you can replace the beneficiary with another blood relation – that means brother, sister, first cousin, even you or your spouse – to continue spending down those funds for educational expenses. Also, if you have a grandchild headed for college, you can arrange for your 529 plan to make the withdrawal payable to your grandchild as the beneficiary.

Take a penalty and spend the money on whatever you want: This isn’t the most sensible financial option, but you do have the option to take leftover funds as a nonqualified distribution for your own non-educational use. However, you’ll owe ordinary federal tax with an additional 10 percent on the earnings portion of the distribution. Don’t forget state tax, either.

Let your successor owner make the decisions. When you apply for the account, you are asked to name a successor owner. When you die, you can simply trust the successor owner or the beneficiary of the funds to do what they want with the money.

March 2010 — This column is produced and is provided by The Jacobs Financial Group. (09-08)

When Doing Your Own Taxes Makes Sense…And When It Doesn’t

Tax deadline is April 15, so if you haven’t begun gathering your annual tax records it’s time to do so. Every year, however, people’s lives change – they buy and sell houses and move, they take new jobs, have kids, buy and sell stock. Those and dozens more reasons might give you cause to hire a tax preparer.

It’s worth going over the primary reasons why some people should get help with their taxes and others can continue going it alone.

Should you do it by yourself? If you meet the following circumstances, you can probably do your taxes by yourself:

• You work for only one employer who gives you a W-2 tax form each year.
• You rent your residence and don’t own a home or vacation property.
• You don’t have kids or other dependents.
• You don’t have any complex investments such as a partnership, a trust or extensive stock holdings.
• You really like numbers, are willing to investigate annual changes to the tax code and double-check your work.
• You’re comfortable doing computations by calculator or by hand, or by using tax software on your computer or online.

For do-it-yourselfers with computers, the Internal Revenue Service’s Free File program is aimed at some 95 million taxpayers with an Adjusted Gross Income (AGI) of $57,000 or less in 2009 to prepare and e-file their federal tax returns for free. E-file, the IRS’s online tax filing service, is available to both tax professionals and individuals with compatible home computer tax software. You can learn more about the e-File program here.

Should you seek help? It generally makes more sense to get help with your taxes if:

• You’re buying or selling property.
• You own a business or rental property.
• You get regular income from a trust or partnership.
• You trade investments frequently or have a complex portfolio.
• You’ve undergone a major financial impact during the previous tax year, such as a divorce, death of a spouse, an inheritance or a move of more than 50 miles for a new job.
• You are supporting a child between the ages of 19 and 24 who is a full-time college student.
• You don’t have time to do it yourself.
• You are subject to the Alternate Minimum Tax (AMT).
• Your income has increased by a considerable amount from the previous year.

You’re still legally responsible for your return even though you have professional help, so it’s important to choose a qualified professional to help you. The IRS gives the following suggestions for finding a qualified preparer:

1. Ask how they charge: Avoid preparers who claim they can obtain larger refunds than other preparers. If your returns are prepared correctly, every preparer should derive substantially similar numbers.
2. Don’t believe promises: If a preparer guarantees results or bases fees on a percentage of the amount of the refund, be suspicious. Tax preparers aren’t allowed to charge a contingent fee (percentage of your refund) for preparing an original tax return.
3. Ask what preparers will need: Reputable preparers will expect you to provide receipts and other paperwork if they need it to justify the return they’re preparing for you. You need to keep scrupulous records.
4. Make sure you know exactly who’s preparing your return: It’s OK if your preparer has onsite staff assistance in preparation of your return, but the person you hire needs to be the person who reviews your return and signs off on it.
5. Investigate your preparer’s record: Check with the Better Business Bureau, the state’s board of accountancy for CPAs, the state’s bar association for attorneys or the IRS Office of Professional Responsibility (OPR) for enrolled agents.
6. Check your preparer’s credentials: Find out if the preparer is affiliated with a professional organization that provides or requires its members to pursue continuing education and holds them accountable to a code of ethics.
7. Stay aware of tax scams: Newspaper business sections and news programs focus on abusive tax shelters and scams. So does www.IRS.gov. If you have a preparer encouraging you to get involved in tax avoidance strategies that are overly complex, check them out before you agree to jump in.

March 2010 — This column is produced and is provided by The Jacobs Financial Group. (03-10)