Saving for Your Retirement

Saving for Your Retirement

Presented by Jared Daniel of Wealth Guardian Group

Major considerations

How much will you need in retirement?

When do you plan to retire? What kind of lifestyle do you desire? How much do you have right now that you can count on for your retirement? What about Social Security; do you know what kind of benefits you can expect? These are all factors you will need to consider when you determine how much you'll need.

Know how much you have

Take an honest look at your present net worth. If you're like most people, you've got a long way to go before you can afford to retire. Knowing how much you currently have earmarked for retirement will assist you in saving for your retirement.

Implement a savings plan

Take an honest look at your current spending. Just as in planning for other financial goals, you need to implement a savings plan. Think about establishing a long-term systematic savings plan to put aside funds for retirement. If you haven't already done so, consider the benefits of establishing and sticking to a spending plan.

Decide where to put your dollars

You've freed up some cash, and you want to put it where it will do the most good. You need to consider some options:

·         Take advantage of employer-sponsored retirement plans

·         Utilize IRAs

·         Evaluate other investment alternatives

Take full advantage of employer-sponsored retirement plans

Taking advantage of retirement plans in general

Does your employer offer a retirement plan? If so, be sure that you're taking full advantage of it. If your employer has a defined benefit plan (a traditional pension plan, with pension benefits typically based on the number of years you work and your level of compensation), make yourself familiar with the details of the plan. Although most aspects of such a plan are beyond your control (e.g., you can't make contributions), you should know how your plan works. How long do you have to work before you have rights under the plan (the plan's vesting schedule)? When are you entitled to a full pension? This information is vital if you're considering leaving your employment.

If your employer offers a defined contribution plan (such as a 401(k) plan, to which contributions can be made by employer and/or employee), much depends upon the specific type of plan. The one feature that these plans have in common is that the contributed funds grow tax deferred. This is significant, because investments in these plans can grow more rapidly than identical investments that don't grow tax deferred. Depending upon the type of plan that you have, you may be able to make voluntary contributions.

Maximize employer-matching contributions

Some retirement savings plans, such as 401(k) plans, 403(b) plans (tax-sheltered annuity plans for employees of public schools and certain tax-exempt organizations), SIMPLE IRAs, and thrift savings plans (plans to which you generally make after-tax contributions), allow employers to match contributions that you make up to a specified level. Since this is basically free money (once you're vested in those employer dollars), consider taking advantage of it. Contribute enough to the plan so that your employer contributes the maximum matching amount. For more information, refer to the specific plan in which you participate.

Self-employed individuals should consider establishing their own retirement plans

If you're self-employed, seriously consider establishing a retirement plan for yourself. For example, a simplified employee pension (SEP) plan is relatively easy to implement (it's really not much more than a big IRA), and it allows you to save significant funds for retirement or you might consider an individual 401(k) plan. If you're a business owner with employees, you should think about setting up an employer-sponsored retirement plan. There are a variety of retirement plans that are appropriate for sole proprietors and partnerships, corporations, and tax-exempt organizations.

If you do contract work for a tax-exempt organization or a state or local government

If you perform services as an independent contractor for a state or local government or a tax-exempt organization that sponsors a Section 457(b) plan (a specific type of deferred compensation plan), you may be able to participate in that plan. If you can participate, you can defer a significant portion of your compensation to the plan.

Individual retirement accounts (IRAs)

Contribute to an IRA each year

IRAs offer significant tax incentives to encourage you to save money for retirement. You can contribute up to $5,500 to your IRA in 2014 ($6,500 if you're age 50 or older), as long as you have at least that amount in compensation for the year. The types of IRAs that you can use (and the corresponding tax advantages) depend upon your income level, filing status, and whether or not you're covered by an employer-sponsored retirement plan.

If your spouse does not have compensation, contribute to an IRA for your spouse

You may be able to set up and contribute to an IRA for your spouse, even if he or she received little or no compensation for the year. To contribute to a spousal IRA, you must meet the following four conditions:

1. You must be married at the end of the tax year
2. You must file a joint federal tax return for the tax year
3. You must have taxable compensation for the year
4. Your spouse's taxable compensation for the year must be less than yours

Choosing investments within your retirement plan

It's important to understand that the earnings potential offered by a retirement plan (e.g., 401(k) or IRA) is not generated by the plan per se, but by the investments held by the plan (e.g., stocks, bonds, mutual funds). Choosing the right mix of investments within your plan is just as important as choosing the right plan itself. When making your choices, many factors should be considered including your time horizon, your tolerance for risk, and the tax implications. For example, it may not make sense to hold tax-exempt securities within a plan that is tax deferred.

The Jobs and Growth Tax Relief Reconciliation Act of 2003 (2003 Tax Act) complicates matters further. The 2003 Tax Act reduced long-term capital gains tax rates and the tax rates on qualifying dividends (0% or 15% depending on your marginal income tax bracket). However, investments held in retirement plans do not benefit from these lower tax rates. Thus, holding investments that generate income subject to these lower rates in a tax-deferred plan is now less appealing. This does not mean that such investments are inappropriate for retirement plans, only that you should consider carefully your overall investment portfolio in deciding what investments to hold within, and outside of, a retirement plan.

Caution:         The reduced tax rates on capital gains and qualifying dividends introduced by the 2003 Tax Act were scheduled to expire after 2010. However, these rates were extended through 2012 by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, and then permanently extended for most taxpayers by the American Taxpayer Relief Act of 2012 (ATRA). However, under

ATRA, individuals with income in 2015 that exceeds $413,200, or married couples filing jointly with income that exceeds $464,850, are subject to a higher rate of 20% for long-term capital gains and qualifying dividends.

Caution:         Health-care reform legislation enacted in 2010 included a new Medicare tax on the unearned income of certain high-income individuals. The tax is equal to 3.8% of the lesser of (a) your net investment income, or (b) your modified adjusted gross income in excess of the statutory dollar amount that applies to you based on your tax filing status ($200,000 for individuals, $250,000 for married couples filing jointly). This tax does not apply to investments held in IRAs and most employer-sponsored retirement plans.

Caution:         All investing involves risk, including the possible loss of principal, and there can be no assurance that any investment strategy will be successful.

Evaluate nonqualified investment programs

Annuities and retirement

Annuities, which are funded with after-tax dollars, grow tax deferred. When you retire, if you're over age 59½, you may make withdrawals or begin taking payments that will continue as long as you live. The tax-deferred earnings portion of these withdrawals or payments will then be taxed as ordinary income. Keep in mind that, as with IRAs, if you withdraw any money from an annuity before you're 59½, you'll generally have to pay an additional 10 percent penalty tax.)

Caution:         Any guarantees are subject to the claims-paying ability of the insurer.

Life insurance and retirement

Some life insurance has certain tax advantages, such as the tax-deferred growth of the cash value of permanent life insurance. This type of life insurance can be a supplementary source of retirement income, in addition to providing financial protection to your beneficiaries.

Review other investments

You should consider carefully your current investment portfolio. Are you putting your money in appropriate investments?

Other considerations

Does your employer offer or are you in a position to take advantage of any of the following?

·         Nonqualified deferred compensation plans            

·         Stock plans            

·         Other employee benefits

            

Choose the right strategy to save for your retirement

You know that you should be taking advantage of employer-sponsored retirement plans, making yearly contributions to IRAs, and considering all of your other options, but how do you decide which to do first? If you have the cash, you should probably be doing all three. If not, conventional wisdom says you should always consider taking advantage of any employer-matching contributions within an employer-sponsored retirement plan. Contribute at least enough to capture the full match offered by your employer.

Beyond that level of savings, you have to think about whether it's better to make additional voluntary contributions to your employer-sponsored retirement plan or put those dollars into an IRA or elsewhere. Annuities and life insurance, for example, play an important role in many peoples' retirement planning.

Certainly, if you have not reached the pretax contribution limit at work, funneling more dollars into your 401(k) or other employer-sponsored plan probably makes the most sense. The ability to make systematic contributions straight from your paycheck is a huge practical plus for most individuals, and the power of tax-deferred savings can be great. Although the traditional IRA also provides tax-deferred growth, the ability to deduct contributions is phased out for high- and middle-income taxpayers also participating in qualified retirement plans. If you earn too much to make a deductible IRA contribution, you should probably fully fund your employer-sponsored retirement plan before making nondeductible contributions to a traditional IRA.

The Roth IRA and Roth 401(k) /403(b) offer yet more options. With these arrangements, you invest after-tax dollars, but you don't pay income tax on the earnings for qualified withdrawals. Tax-free earnings are even better than tax-deferred earnings because tax-deferred earnings will eventually be taxed when you start taking distributions. In deciding between a Roth IRA and a traditional IRA or other alternative, or between pre-tax and Roth 401(k)/403(b) contributions, you should consult a financial professional who can make some planning assumptions and crunch the numbers to see what makes the most sense.

Jared Daniel may be reached at www.WealthGuardianGroup.com or our Facebook page.

IMPORTANT DISCLOSURESBroadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual's personal circumstances.To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law.  Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials.  The information in these materials may change at any time and without notice.

Wealth Due to Inheritance

Wealth Due to Inheritance

Presented by Jared Daniel of Wealth Guardian Group

What is it?

Introduction

If you're the beneficiary of a large inheritance, you may find yourself suddenly wealthy. Even if you expected the inheritance, you may be surprised by the size of the bequest or the diverse assets you've inherited. You'll need to evaluate your new financial position, learn to manage your sizable assets, and consider the tax consequences of your inheritance, among other issues.

Issues that arise in connection with an inheritance

If you've recently received a bequest, consider the possibility that the will may be contested if your inheritance was large in comparison with that received by other beneficiaries. Or, you may decide to contest the will if you feel slighted. If you're the spouse of the decedent, you may elect to take against the will. Taking against the will means that you're exercising your right under probate law (governed by the statutes of your state) to take a share of your spouse's estate, rather than what your spouse left you in the will, because this is more beneficial to you. Another possibility is that you may disclaim the bequest if you're in a high income or estate tax bracket, or don't need or want the bequest.

Caution:         Some states allow no-contest clauses to be included in wills. If a will has such a clause and someone contests the will and loses, he or she gets nothing.

Evaluating your new financial position

Introduction

It's important to determine how wealthy you are once you receive your inheritance. Before you spend or give away any money or assets, decide to move, or leave your job, you should do a cash flow analysis and determine your net worth as a first step toward planning your financial strategy. Your strategy will partly depend on whether you have immediate access to, and total control over, the assets, or if they're being held in trust for you. In addition, you need to know what types of assets you've inherited (e.g., cash, property, or a portfolio of stocks).

Inheriting assets through a trust vs. inheriting assets outright

When you inherit money and assets through a trust, you'll receive distributions according to the terms of the trust. This means that you won't have total control over your inheritance as you would if you inherited the assets outright. With a trust, a trustee will be in charge of the trust. A trustee is the person who manages the trust for the benefit of the beneficiary or beneficiaries. The initial trustee was named by the individual who set up the trust. The trustee will likely be your parent or other family member, a close family friend or advisor, an attorney, or a bank representative. The trust document may spell out how the trust assets will be managed and how and when trust income and assets will be paid to you, and it will outline the duties of the trustee.

Know the terms of the trust

If you're the beneficiary of a trust, the following should be done to ensure that your interests are protected:

·         Read the trust document carefully. You have the right to see the document, so if you can't get a copy, hire an attorney to get it. Go over the document yourself or with the help of a legal or financial professional, making sure you understand the language of the trust and how its income and principal will be distributed to you. You may be the beneficiary of an irrevocable trust (can't be changed), or you may be the beneficiary of a revocable trust (can be changed). In addition, determine whether certain practices are allowed or prohibited. For example, one common trust provision prohibits a beneficiary from borrowing against the trust. Another can prevent the beneficiary from paying creditors with assets of the trust. An additional provision usually prohibits creditors from attaching a beneficiary's share of the trust.

·         Determine if the trust income is sufficient to meet your needs. Is the trust heavily invested in long-term growth stocks or nonrental real estate? Or, is the trust invested in things that provide income to you now, such as rental real estate or money market funds? From your agent (e.g., attorney, accountant) or trustee, get the income statements used to calculate how much income will be distributed to you.

·         Get to know your trust officers (if any) and find out how much the trustee fees are. Then, compare the fee with the average in your state or county (you might ask your local bank for this information). You may be able to negotiate the fee if it is too high, especially if the estate is large.

Working with a trustee

In some trusts, the trustee must distribute all of the income to the beneficiary every year. This type of trust may be simple to administer and relatively conflict free. You may want to work with the trustee or other professionals to ensure that the annual trust distribution is adequate to meet your needs.

In other trusts, the trustee may decide when to distribute trust income and how much to distribute. If this is the case, open communication with the trustee is important. You'll need to set up a sound budget or financial plan and carefully prepare your request for a trust distribution if it is out of the ordinary. It's in your best interests to find a way to work with the trustee. In most states, trustees are difficult to replace, and although they're not supposed to lose money on investments, they're not usually penalized if the trust performs poorly. If you decide to sue the trustee for mismanaging the trust, his or her legal fees may be paid for from the trust.

Caution:         No matter how trust funds are distributed, pay close attention to how the trustee handles the trust investments. Have your lawyer, accountant, or financial advisor look over the trustee's investment strategy. If your advisor determines that the trustee's investment strategy doesn't meet your needs or, worse, is unsound, discuss this strategy with the trustee or possibly ask the trustee to change his or her strategy.

Inheriting a lump sum of cash

When you inherit a large lump sum of cash, you'll be responsible for managing the money yourself (or hiring professionals to do so). Even if you're used to handling your own finances, becoming suddenly wealthy can turn even the most cautious individual into a spendthrift, at least in the short run. Carefully watch your spending. Although you may want to quit your job, move, gift assets to family members or to charity, or buy a car, a house, or luxury items, this may not be in your best interest. You must consider your future needs, as well, if you want your wealth to last. It's a good idea to wait a few months or a year after inheriting money to formulate a financial plan. You'll want to consider your current lifestyle, consider your future goals, formulate a financial strategy to meet those goals, and determine how taxes may reduce your estate.

Inheriting stock

You may inherit stock either through a trust or outright. The major question to consider is whether you should sell the stock. This depends on your overall investment strategy and what type of stock you've acquired. If you acquire stock in a company, for example, and you now own a controlling interest, you'll need to look at how actively you want to be involved in the company or how much you know about the company. If you inherit stock and find that it doesn't fit your portfolio, you may consider selling it, depending on the market conditions.

Inheriting real estate

If you inherit real estate, such as a house or land, you'll probably have to decide whether to keep it or sell it. If you keep it, will you live there or rent it out? Do you hope that the house will appreciate in value, or are you keeping it for sentimental reasons? If you decide to sell or rent the house, you'll need to consider the tax consequences, as well.

Tip:     It's possible that you may inherit real estate or other assets together with others, and sales may require the other owners' assent or court action to sever the property.

Short-term and long-term needs and goals

Once you've done a cash flow analysis and determined what type of assets you've inherited, you need to evaluate your short-term and long-term needs and goals. For example, in the short term, you may want to pay off consumer debt such as high-interest loans or credit cards. Your long-term planning needs and goals may be more complex. You may want to fund your child's college education, put more money into a retirement account, invest, plan to minimize taxes, or travel.

Use the following questions to begin evaluating your financial needs and goals, then seek advice on implementing your own financial strategy:

·         Do you have outstanding consumer debt that you would like to pay off?

·         Do you have children you need to put through college?

·         Do you need to bolster your retirement savings?

·         Do you want to buy a home?

·         Are there charities that are important to you and whom you wish to benefit?

·         Would you like to give money to your friends and family?

·         Do you need more income currently?

·         Do you need to find ways to minimize income and estate taxes?

Tax consequences of an inheritance

Income tax considerations

In general, you won't directly owe income tax on assets you inherit. However, a large inheritance may mean that your income tax liability will eventually increase. Any income that is generated by those assets may be subject to income tax, and if the inherited assets produce a substantial amount of income, your tax bracket may increase. Once you increase your wealth, you should look at ways to minimize your overall tax liability, such as shifting income, giving money to individuals or charity, utilizing other income tax reduction strategies, and investing for growth rather than income. You may also need to re-evaluate your income tax withholding or begin paying estimated tax.

Transfer tax considerations

If you're wealthy, you'll need to consider not only your current income tax obligations but also the amount of potential transfer taxes that may be owed. You may need to consider ways to minimize these potential taxes. Four common ways to do so are to (1) set up a marital trust, (2) set up an irrevocable life insurance trust, (3) set up a charitable trust, or (4) make gifts to individuals and/or to charities.

Impact on investing

Inheriting an estate can completely change your investment strategy. You will need to figure out what to do with your new assets. In doing so, you'll need to ask yourself several questions:

·         Is your cash flow OK? Do you have enough money to pay your bills and your taxes? If not, consider investments that can increase your cash flow.

·         Have you considered how the assets you've inherited may increase or decrease your taxes?

·         Do you have enough liquidity? If you need money in a hurry, do you have assets you could quickly sell? If not, you may want to consider having at least some short-term, rather than long-term, investments.

·         Are your investments growing enough to keep up with or beat inflation? Will you have enough money to meet your retirement needs and other long-term goals?

·         What is your tolerance for risk? All investments carry some risk, including the potential loss of principal, but some carry more than others. How well can you handle market ups and downs? Are you willing to accept a higher degree of risk in exchange for the opportunity to earn a higher rate of return?

·         How diversified are your investments? Because asset classes often perform differently from one another in a given market situation, spreading your assets across a variety of investments such as stocks, bonds, and cash alternatives, has the potential to help reduce your overall risk. Ideally, a decline in one type of asset will be at least partially offset by a gain in another, though diversification can't guarantee a profit or eliminate the possibility of market loss.

Once you've considered these questions, you can formulate a new investment strategy. However, if you've just inherited money, remember that there's no rush. If you want to let your head clear, put your funds in an accessible interest-bearing account such as a savings account, money market account, or a short-term certificate of deposit until you can make a wise decision with the help of advisors.

Impact on insurance

When you inherit wealth, you'll need to re-evaluate your insurance coverage. Now, you may be able to self-insure against risk and potentially reduce your property/casualty, disability, and medical insurance coverage. (However, you might actually consider increasing your coverages to protect all that you've inherited.) You may want to keep your insurance policies in force, however, to protect yourself by sharing risk with the insurance company. In addition, your additional wealth results in your having more at risk in the event of a lawsuit, and you may want to purchase an umbrella liability policy that will protect you against actual loss, large judgments, and the cost of legal representation. If you purchase expensive items such as jewelry or artwork, you may need more property/casualty insurance to protect yourself in the event these items are stolen. You may also need to recalculate the amount of life insurance you need. You may need more life insurance to cover your estate tax liability, so your beneficiaries receive more of your estate after taxes.

Impact on estate planning

Re-evaluating your estate plan

When you increase your wealth, it's probably time to re-evaluate your estate plan. Estate planning involves conserving your money and putting it to work so that it best fulfills your goals. It also means minimizing your exposure to potential taxes and creating financial security for your family and other intended beneficiaries.

Passing along your assets

If you have a will, it is the document that determines how your assets will be distributed after your death. You'll want to make sure that your current will reflects your wishes. If your inheritance makes it necessary to significantly change your will, you should meet with your attorney. You may want to make a new will and destroy the old one instead of adding codicils. Some things you should consider are whom your estate will be distributed to, whether the beneficiary(ies) of your estate are capable of managing the inheritance on their own, and how you can best shield your estate from estate taxes. If you have minor children, you may want to protect them from asset mismanagement by nominating an appropriate guardian or setting up a trust for them.

Using trusts to ensure proper management of your estate and minimize taxes

If you feel that your beneficiaries will be unable to manage their inheritance, you may want to set up trusts for them. You can also use trusts for tax planning purposes. For example, setting up an irrevocable life insurance trust may minimize federal and state transfer taxes on the proceeds.

Impact on education planning

You may want to use part of your inheritance to pay off your student loans or to pay for the education of someone else (e.g., a child or grandchild). Before you do so, consider the following points:

·         Pay off outstanding consumer debt first if the interest rate on your consumer debt is higher than it is on your student loans (interest rates on student loans are often relatively low)

·         Paying part of the cost of someone else's education may impact his or her ability to get financial aid

·         You can make gifts to pay for tuition expenses without having to pay federal transfer taxes if you pay the school directly

Giving all or part of your inheritance away

Giving money or property to individuals

Once you claim your inheritance, you may want to give gifts of cash or property to your children, friends, or other family members. Or, they may come to you asking for a loan or a cash gift. It's a good idea to wait until you've come up with a financial plan before giving or lending money to anyone, even family members. If you decide to loan money, make sure that the loan agreement is in writing to protect your legal rights to seek repayment and to avoid hurt feelings down the road, even if this is uncomfortable. If you end up forgiving the debt, you may owe gift taxes on the transaction. Gift taxes may also affect you if you give someone a gift of money or property or a loan with a below-market interest rate. The general rule for federal gift tax purposes is that you can give a certain amount ($14,000 in 2014) each calendar year to an unlimited number of individuals without incurring any tax liability. If you're married, you and your spouse can make a split gift, doubling the annual gift tax exclusion amount (to $28,000) per recipient per year without incurring tax liability, as long as all requirements are met. Giving gifts to individuals can also be a useful estate planning strategy.

Tip:     The annual gift tax exclusion is indexed for inflation, so the amount may change in future years.

Caution:         This is just a brief discussion of making gifts and gift taxes. There are many other things you will need to know, so be sure to consult an experienced estate planning attorney.

Giving money or property to charity

If you make a gift to charity during your lifetime, you may be able to deduct the amount of the charitable gift on your income tax return. Income tax deductions for gifts to charities are limited to 50 percent of your contribution base (generally equal to adjusted gross income) and may be further limited if the gift you make consists of certain appreciated property or if the gift is given to certain charities and private foundations. However, excess deductions can usually be carried over for five years, subject to the same limitations. For estate planning purposes, you may want to make a charitable gift that can minimize the amount of transfer taxes your estate may owe.

Jared Daniel may be reached at www.WealthGuardianGroup.com or our Facebook page.
IMPORTANT DISCLOSURESBroadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual's personal circumstances.To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law.  Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials.  The information in these materials may change at any time and without notice.

College Saving Options

College Saving Options

Presented by Jared Daniel of Wealth Guardian Group

College costs

For the 2013/2014 college year, the average annual cost of attendance (known as the COA) at a four-year public college for in-state students is $22,826, the average cost at a four-year public college for out-of-state students is $36,136, and the average cost at a four-year private college is $44,750. The COA figure includes tuition and fees, room and board, books and supplies, transportation, and personal expenses. (Source: The College Board's 2013 Trends in College Pricing Report.)

College savings options

It is important for parents to start putting money aside for college as early as possible. But where should you put your money? There are many possibilities, each with varied features. For example, some options offer tax advantages, some are more costly to establish, some charge management fees, some require parental income to be below a certain level, and some impose penalties if the money is not used for college.

Following is a list of options:

·         529 college savings plans

·         529 prepaid tuition plans

·         Coverdell education savings accounts

·         Custodial accounts (UTMA/UGMA)

·         Gifting

·         U.S. savings bonds

·         Traditional IRAs and Roth IRAs

·         Employer-sponsored retirement plans

·         Employee stock purchase plans

·         Cash value life insurance

·         2503 trusts

·         Crummey trusts

·         Tax-deferred annuities

·         Other tax-advantaged strategies

·         Options unique to business owners

Factors that may affect college savings decisions

When investing for college, there are several factors to consider.

Tax advantages

Money saved for college goes a lot further when it's allowed to accumulate tax free or tax deferred. To come out ahead in the college savings game, it's wise to consider tax-advantaged strategies.

Example(s):   Assume that every year you put money away in a non tax-advantaged investment that earns 9 percent. If your earnings are subject to a 33 percent tax rate (federal and state), your after-tax return is 6 percent.

Now assume you put the same amount of money every year into a tax-advantaged vehicle, such as a 529 plan that earns 9 percent per year. If you later withdraw the money to pay qualified education expenses, you have no tax liability. So, your after-tax return is 9 percent.

The result is that in some cases your return can be greater with a tax-advantaged strategy like a 529 plan than with an investment that offers no special tax advantages (although there is no guarantee that an investment will generate any earnings).

Kiddie tax

Many parents believe they can shift assets to their child in order to avoid high income taxes. This strategy works best if the child is generally age 24 or older. If the child is under age 24, the kiddie tax rules apply.

The basic tax rules are as follows:

·         For children age 18 or under age 24 if a full-time student, the first $1,000 of annual unearned income (e.g., interest, dividends, capital gains) is tax free, the second $1,000 is taxed at the child's rate, and any unearned income over $2,000 is taxed at the parents' rate. This latter tax is referred to as the kiddie tax. So, after the first $2,000 of investment income, a child under age 24 will end up paying the same tax as if the parents had retained the asset.

·         For children age 24 or older, the first $1,000 of annual unearned income is tax free, and all earnings over $1,000 are taxed at the child's rate. if the child is in a lower percent tax bracket, the child will pay less tax than his or her parents would pay on the same income.

Tip:     One way parents may avoid the kiddie tax is to put their child's savings in tax-free or tax-deferred investments so that any taxable income is postponed until after the child reaches age 24 (when the child is taxed at his or her own rate). Such investments can include U.S. savings bonds or tax-free municipal bonds. Alternatively, parents can try to hold just enough assets in their child's name so that the investment income remains under $2,000.

Financial aid

Whether or not a child will qualify for financial aid (e.g., loan, grant, scholarship, or work-study) may affect parental savings decisions. The majority of financial aid is need-based, meaning that it's based on a family's ability to pay.

Predicting whether a child will qualify for financial aid many years down the road is an inexact science. Some families with incomes of $100,000 or more may qualify for aid, while those with lesser incomes may not. Income is only one of the factors used to determine financial aid eligibility. Other factors include amount of assets, family size, number of household members in college at the same time, and the existence of any special personal or financial circumstances.

If a child is expected to qualify for financial aid (and most do), parents should be aware of the formula the federal government uses to calculate aid--called the federal methodology--because there can be a financial aid impact on long-term savings decisions. The more money a family is expected to contribute to college costs, the less financial aid a child will be eligible for.

Briefly, under the federal methodology, parents are expected to contribute 5.6 percent of their assets to college costs each year, and students are expected to contribute 20 percent of their assets each year.

Example(s):   For example, $20,000 in your child's savings account would translate into a $4,000 expected contribution ($20,000 x 0.20), but the same money in your account would result in a $1,120 expected contribution ($20,000 x 0.056).

Also, the federal methodology excludes some parental assets from consideration in determining a family's total assets:

·         Retirement accounts (e.g., IRA, 401(k) plan, 403(b) plan, Keogh plan)

·         Home equity in a primary residence or family farm

·         Cash value life insurance

·         Annuities

Thus, all options being equal, parents may choose to put their money into one or more of these nonassessable assets.

Caution:         Although the federal government excludes these assets, individual colleges have discretion whether to consider them in determining a family's ability to pay college costs.

Time frame

Time frame is a very important consideration. Is the child in preschool or a freshman in high school? Obviously, most college savings strategies work best when the child is many years away from college. With a longer time horizon, parents can be more aggressive in their investments and have more years to take advantage of compounding.

When the child is a baby up until about middle school, most professional financial planners recommend putting more money into equity investments because historically, over the long term, equities have provided higher returns than other types of investments (though past performance is no guarantee of future results). Then, as the child moves from middle school to high school, it's usually wise for parents to start shifting a portion of their equities toward shorter-term, fixed income investments.

If the time frame is only a few years, parents will be limited in their choice of appropriate strategies. For example, if the child were in high school, equities normally would not be a preferred strategy due to the short-term volatility of these investments. Similarly, parents would not have enough time to build up cash value in a life insurance policy.

Amount of money available to invest

The amount of money parents have to invest at a particular time might affect their savings strategies. For example, if parents have only a small amount of money to invest, trusts probably aren't the best option because they are typically more costly to establish and maintain than other college saving options. In this case, a 529 plan may be more appropriate.

Control issues

Generally, when parents give money or property to their child, they lose control of those assets. Such a loss of parental ownership can take place immediately, as in the case of an outright gift of stock certificates, or it may be delayed, as in the case of a custodial account or trust. In any event, parents must assess their personal feelings about relinquishing control of assets to their child. Some children may not be mature enough to handle such assets, whereas others can be counted on to use them for college costs.

Discussing a college funding plan with your child

As college expenses continue to rise relative to the means of the average family to pay such costs in full, parents may find it helpful to sit down with their older children and discuss ways to pay for college. For example, parents may want to discuss:

·         Whether they intend to fund 100 percent of college costs or whether they expect their child to contribute and, if so, in what amount. For example, parents might convey their expectation that their child contribute a certain percentage of all earnings from a part-time job or a portion of all gifts.

·         Whether the child will play a role in the savings strategy. For example, parents who want to gift appreciated stock to their child should convey their expectation that the child will apply all of the gains to college costs.

·         Whether any money will need to be borrowed, and if so, how much and in whose name the loan(s) will be obtained. The amount that needs to be borrowed may affect the type of college the child applies to (e.g., public or private, top tier or middle tier).

·         Whether there will need to be shared financial responsibility during the college years. For example, the child may need to participate in a work-study program or obtain outside work during the college years.

Communicating these expectations ahead of time can prevent unpleasant surprises and help parents and their children better plan for the expenses that lie ahead. Also, an open discussion can give children an increased awareness of the financial burden their parents may be undertaking on their behalf.

Dilemma of saving for college and retirement

For many parents, especially those who started families in their 30s and 40s, the problem of saving for college and retirement at the same time is a nagging reality. Most financial planning professionals recommend saving for both at the same time. The reason is that parents typically can't afford to delay saving for their retirement until the college years are over, because doing so would mean missing out on years of tax-deferred growth and, possibly, employer-matching 401(k) plan contributions.

The key to saving for both is for parents to tailor their monthly investment to the particular investment goal--college or retirement. Parents will then need to determine their time frames and liquidity needs for each goal, which may require the assistance of a financial planning professional.

Jared Daniel may be reached at www.WealthGuardianGroup.com or our Facebook page.
IMPORTANT DISCLOSURESBroadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual's personal circumstances.To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law.  Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials.  The information in these materials may change at any time and without notice.