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Author: Wavelength One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121114  
Subject: Educ. IRAs - some basic questions Date: 12/16/1998 6:15 PM
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<Note: I posted this on the Paying for College board yesterday, but it got no response, so I figured I'd try here.>

I have a few basic questions about educational IRAs, and have seen some posts that seem to contradict some of what I understood to be true when I set these accounts up for my children

1) The accounts that I set up ended up being titled in my name with my children listed as beneficiaries. They are not custodial accounts. I assume this means that I have total control over the money now, and also in the future, even after my children turn 18. I don't want my kids able to say, "Heck, I've decided I don't want to go to college, I'll pay the taxes and penalties since this is free money anyway." In addition, I want to be the one to decide if and when the account gets rolled over to a sibling if the child does not enter college or if the funds aren't totally used up by the time they graduate. Can anyone confirm with authority that these two assuptions on my part are indeed correct?

2) As I stated, I have set up accounts for each of my kids (ages 1, 7, 10, and 12). Will I be able to roll over any unused amounts from one child to the next, even though they already have Ed IRA accounts established in their names and I've been contributing the maximum amount each year? It seems to me that should one find some other way to fund the other children's education (or God forbid they opt out of college), then this could be used by parents of multiple children to essentially multiply the amount available to put away tax free earnings for the last child. Also, the effective length of time to contribute to an education IRA can be increased significantly beyond 18 years. If I contribute to my 1 year old's Ed IRA, and end up having another child 10 years from now, I could end up contributing 18 years to the future child, plus roll over my current child's Ed IRA to him/her, giving me an effective 28 years of contributions and tax free accumulation for my future child (ie I get the multiple contribution amount for the time both children are under 18, PLUS I get to stretch out the effective time for tax free compounding). All assuming I find some other way of paying for the first few children's college expenses, of course. Seems like a good deal, and lots of cash could end up in the account of the last child.

The reason I'm thinking this way, is that The HOPE and Lifetime education tax credits are exclusive to Ed IRA disbursements, so I may find it advantageous to find a way to use these tax credits for the early children, and hopefully shove enough cash over to the last kid's account to be able to truly pay for all college expenses (little hope of doing this with just $500/year contributions) in a tax free manner.

3)Directly related to question 1), who's money is it really? Should some money be left over, the child reaches age 30, or doesn't go to college, taxes will be due and a 10% penalty paid (am I correct in assuming taxes will be due only on the amount of earnings over and above whatever was used for ed. expenses [ie if the amount left over is less than or equal to my original - non-deductable - contributions, no tax is owed], but the penalty must be paid on the entire final disbursement amount, including my contributions?) Do I receive the disbursement and pay the tax/penalties, or the beneficiary? Seems to me it would still be my money, or else it would be a gift to the child, and a way of getting around the $10k/year gift limitation.

Comments?

Wavelength
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Author: TMFTaxes Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7290 of 121114
Subject: Re: Educ. IRAs - some basic questions Date: 12/16/1998 9:26 PM
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[[<Note: I posted this on the Paying for College board yesterday, but it got no response, so I figured
I'd try here.>]]

You only waited a day? Many times it takes me 2 or 3 days to get to the various questions posted here. So don't be too quick on the trigger.

[[ I have a few basic questions about educational IRAs, and have seen some posts that seem to
contradict some of what I understood to be true when I set these accounts up for my children]]

Well, you can read my post on the Ed IRA in the Taxes FAQ area (archives section) to see what I have to say about the Ed IRA. There are also a number of other education related posts that may be of interest to you and your family. You should check it out.

[[ 1) The accounts that I set up ended up being titled in my name with my children listed as
beneficiaries. ]]

Correct. That is how the accounts are required to be established.

[[They are not custodial accounts. I assume this means that I have total control over
the money now, and also in the future, even after my children turn 18.]]

That is basically true.

[[ I don't want my kids able to
say, "Heck, I've decided I don't want to go to college, I'll pay the taxes and penalties since this is
free money anyway."]]

While this is a type of custodial account, it is my understanding that the kids don't have this type of control...the same control that they WOULD have in a normal custodial account.

[[ In addition, I want to be the one to decide if and when the account gets
rolled over to a sibling if the child does not enter college or if the funds aren't totally used up by the
time they graduate. Can anyone confirm with authority that these two assuptions on my part are
indeed correct?]]

What kid of authority would you like? I'll be glad to give you the IRS code section so that you can read it (and make the interpretation) for yourself. But other than that, I don't know what other type of authority you would need.

[[ 2) As I stated, I have set up accounts for each of my kids (ages 1, 7, 10, and 12). Will I be able to
roll over any unused amounts from one child to the next, even though they already have Ed IRA
accounts established in their names and I've been contributing the maximum amount each year?]]

Yup. there are no restrictions (or a maximum amount) relative to Ed IRA accounts. They can grow to whatever the grow to...even if they grow by rollovers from another sibling.

[[ It
seems to me that should one find some other way to fund the other children's education (or God
forbid they opt out of college), then this could be used by parents of multiple children to essentially
multiply the amount available to put away tax free earnings for the last child.]]

Basically a true statement.

[[ Also, the effective
length of time to contribute to an education IRA can be increased significantly beyond 18 years.]]

Again, a true statement. These are tax "tricks" that we have been talking about here for almost a year. You need to be hangin' around a better class of folder :-)

[[ If I
contribute to my 1 year old's Ed IRA, and end up having another child 10 years from now, I could
end up contributing 18 years to the future child, plus roll over my current child's Ed IRA to him/her,
giving me an effective 28 years of contributions and tax free accumulation for my future child (ie I
get the multiple contribution amount for the time both children are under 18, PLUS I get to stretch
out the effective time for tax free compounding).]]

Again, you are right on the mark.

[[ All assuming I find some other way of paying for
the first few children's college expenses, of course. Seems like a good deal, and lots of cash could
end up in the account of the last child.]]

Again, true...

[[ The reason I'm thinking this way, is that The HOPE and Lifetime education tax credits are
exclusive to Ed IRA disbursements, so I may find it advantageous to find a way to use these tax
credits for the early children, and hopefully shove enough cash over to the last kid's account to be
able to truly pay for all college expenses (little hope of doing this with just $500/year contributions)
in a tax free manner.]]

Then I'm sure that you'll be intersted in my posts on the Hope and Lifetime credits...not to mention some tax strategies dealing with the interaction of all of these credits. Again, you'll find all of this information in the Taxes FAQ area.

[[ 3)Directly related to question 1), who's money is it really? Should some money be left over, the
child reaches age 30, or doesn't go to college, taxes will be due and a 10% penalty paid ]]

Again...correct.

[[(am I
correct in assuming taxes will be due only on the amount of earnings over and above whatever was
used for ed. expenses [ie if the amount left over is less than or equal to my original -
non-deductable - contributions, no tax is owed],]]

Yes..that is correct. Only the earnings will be subject to taxes. None of the original contributions will be subject to taxes or penalties.

[[ but the penalty must be paid on the entire final
disbursement amount, including my contributions?)]]

Nope. The penalty is paid on the earnings only. Not on the original contributions. Similar to a non-deductible IRA contribution. It would be patently unfair (not that fairness has anything to do with taxes) to penalize the original contribution...something that you never received a tax break on.

[[ Do I receive the disbursement and pay the
tax/penalties, or the beneficiary?]]

The beneficiary will get hit for the taxes and penalties. The funds will also belong to the beneficiary.

[[ Seems to me it would still be my money, or else it would be a gift
to the child, and a way of getting around the $10k/year gift limitation.]]

Remember that gifts to children who don't get full control of the funds at the age of majority are NOT gifts of future interest, and don't fall under the $10k annual exclusion. Since the beneficiary, in the case of an ED IRA, doesn't have complete control of the funds at majority, the $10k gift tax exclusion doesn't apply. But the Ed IRA is not a gift...more in the form of a trust. That allows the best of all rules. The custodian (or trustee) controls the funds, but the funds are totally for the benefit of the beneficiary of the trust.

So the account really works more like a trust than a UGMA or UTMA account. That is why it acts a bit different.

[[ Comments?]]

You got 'em. How about yours??

TMF Taxes
Roy

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Author: Wavelength One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7297 of 121114
Subject: Re: Educ. IRAs - some basic questions Date: 12/16/1998 10:38 PM
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TMFTaxes:

Thanks so much for your clear and concise replies to my questions!
Just to let you know, I had already checked out your FAQs on Ed IRAs, Hope, and Lifetime tax credits, but the nuances I was after were not addressed there. They were, however, nicely written and very helpful.
I was so quick to jump ship to this board because while you are clearly present giving out your excellent advice here, I did not notice a Fool holding court on the Paying for College board, and so thought it was quite probable that none of the readers would get around to answering my questions [OK, so I just got impatient :) ]. BTW, someone with your demonstrated knowledge of the tax laws is all the "authority" I was looking for.
I actually find it very interesting how this type of account has all the earmarks of a trust, and am grateful to you for pointing out the benefits of this.

One more quick question: after having shoved any leftover/unused funds from one child to the next until it is all in the account of the last child, should a miracle occur and I see that there will be a decent amount left over after paying for her education, I assume it will be OK to put back money into the older kids' accounts in an equal manner, assuming they are all under the age of 30 when I do so? With 4 kids, I've learned that the appearance of "fairness" is very important to avoiding complaints, and I assume this won't change as they get older :) .

Wavelength

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Author: TMFTaxes Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7316 of 121114
Subject: Re: Educ. IRAs - some basic questions Date: 12/17/1998 7:05 PM
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[[Thanks so much for your clear and concise replies to my questions!]]

You are very welcome...

[[ Just to let you know, I had already checked out your FAQs on Ed IRAs, Hope, and Lifetime tax
credits, but the nuances I was after were not addressed there.]]

No problem at all. I just wanted to make sure that you knew they were there...

[[ BTW, someone with your demonstrated knowledge of the tax
laws is all the "authority" I was looking for.]]

No problem. I get 'em wrong from time to time also. But I just wasn't sure if you wanted to see code sections, or whatever. If you do, I'll be glad to e-mail 'em to you. You make the call.

[[ One more quick question: after having shoved any leftover/unused funds from one child to the next
until it is all in the account of the last child, should a miracle occur and I see that there will be a
decent amount left over after paying for her education, I assume it will be OK to put back money
into the older kids' accounts in an equal manner, assuming they are all under the age of 30 when I
do so?]]

Sure. Nothing in the law limits the transaction that you describe. Nothing at all.

[[ With 4 kids, I've learned that the appearance of "fairness" is very important to avoiding
complaints, and I assume this won't change as they get older :) .]]

I'm sure that you are VERY correct!!!

TMF Taxes
Roy

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