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10 Tips for Helping Families with Special Needs

Volume 2, Issue 2

This issue of our newsletter examines the unique planning requirements of families with children, grandchildren or other family members (such as parents) with special needs. There are many misconceptions in this area that result in costly mistakes in planning for special needs beneficiaries. There are many misconceptions in this area that result in costly mistakes in planning for special needs beneficiaries. It is, therefore, incumbent upon us – our clients’ advisors – to ensure that clients understand all of their options.

Costly Mistake #1: Disinheriting the special needs beneficiary.

Many disabled people rely on SSI, Medicaid or other government benefits to provide food and shelter. Your clients may have been advised to disinherit their special needs beneficiaries – beneficiaries who need their help most – to protect those beneficiaries’ public benefits. But these benefits rarely provide more than basic needs. And this “solution” does not allow your clients to help their special needs beneficiaries after the clients become incapacitated or are gone. When a loved one requires, or is likely to require, governmental assistance to meet his or her basic needs, parents, grandparents and others should consider establishing a Special Needs Trust.

Planning Tip:  It is unnecessary and in fact poor planning to disinherit special needs beneficiaries. Clients with special needs beneficiaries should consider a Special Needs Trust to protect public benefits and care for those beneficiaries during their own incapacity or after their death.

Costly Mistake #2: Procrastinating.

Because none of us knows when we may die or become incapacitated, it is important that your clients plan for a beneficiary with special needs early, just as they should for other dependents such as minor children. However, unlike most other beneficiaries, special needs beneficiaries may never be able to compensate for a failure to plan. Minor beneficiaries without special needs can obtain more resources as they reach adulthood and can work to meet essential needs, but special needs beneficiaries may never have that ability.

Planning Tip:  Parents, grandparents, or any other loved ones of a special needs beneficiary face unique planning challenges when it comes to that child. This is one area where clients simply cannot afford to wait to plan.

Costly Mistake #3: Failing to coordinate a planning team effort.

It is critical that advisors assisting with special needs planning include in the planning team: an attorney who is experienced in this planning area; a life insurance agent who can ensure that there will be enough money to maintain the benefits for the special needs child; a CPA who can advise on the Special Needs Trust’s tax return; an investment advisor who can help ensure that the trust fund’s resources will last for the special needs beneficiary’s lifetime; and any other key advisors that may support the goals of the trust going forward.

Planning Tip:  Special needs planning dictates that clients’ advisors work together to ensure that there are sufficient trust assets to care for special needs beneficiaries throughout their lifetime.

Costly Mistake #4: Ignoring the special needs when planning for a special needs beneficiary.

Planning that is not designed with the beneficiary’s special needs in mind will probably render the beneficiary ineligible for essential government benefits. A properly designed Special Needs Trust promotes the special needs person’s comfort and happiness without sacrificing eligibility.

Special needs can include medical and dental expenses, annual independent check-ups, necessary or desirable equipment (for example, a specially equipped van), training and education, insurance, transportation and essential dietary needs. If the trust is sufficiently funded, the disabled person can also receive spending money, electronic equipment & appliances, computers, vacations, movies, payments for a companion, and other self-esteem and quality-of-life enhancing expenses: the sorts of things your clients now provide to their child or other special needs beneficiary.

Planning Tip:  When planning for a beneficiary with special needs, it is critical that clients utilize a Special Needs Trust as the vehicle to pass assets to that beneficiary. Otherwise, those assets may disqualify the beneficiary from public benefits and may be available to repay the state for the assistance provided.

Costly Mistake #5: Creating a “generic” special needs trust that doesn’t fit.

Even some “special needs trusts”” are unnecessarily inflexible and generic. Although an attorney with some knowledge of the area can protect almost any trust from invalidating the beneficiary’s public benefits, many trusts are not customized to the particular beneficiary’s needs. Thus the beneficiary fails to receive the benefits that the parents or others provided when they were alive.

Another frequent mistake occurs when the Special Needs Trust includes a “pay-back” provision rather than allowing the remainder of the trust to go to others upon the death of the special needs beneficiary. While these “pay-back” provisions are necessary in certain types of special needs trusts, an attorney who knows the difference can save your clients hundreds of thousand of dollars, or more.

Planning Tip:  A Special Needs Trust should be customized to meet the unique circumstances of the special needs beneficiary and should be drafted by a lawyer familiar with this area of the law.

Costly Mistake #6: Failing to properly “fund” and maintain the plan.

When planning for a beneficiary with special needs, it is absolutely critical that there are sufficient assets available for the special needs beneficiary throughout his or her lifetime. In many instances, this requires utilization of a funding vehicle that can ensure liquidity when necessary. Oftentimes permanent life insurance is the perfect vehicle for this purpose, particularly for young and healthy clients while insurance rates are low.

Also, because this is an ever-changing area, it is imperative that clients revisit their plan frequently to ensure that it continues to meet the needs of the special needs beneficiary.

Planning Tip:  Clients should consider permanent life insurance as the funding vehicle for special needs beneficiaries, particularly with young beneficiaries given the often staggering costs anticipated over their lifetime.

For clients subject to estate tax, consider having an Irrevocable Life Insurance Trust own and be the beneficiary of the policy, naming the Special Needs Trust as a beneficiary. Alternatively, in a non-taxable situation, consider naming their revocable trust as the beneficiary to help equalize inheritances.

Costly Mistake #7: Choosing the wrong trustee.

Clients can manage the trust while alive and well. Once they are no longer able to serve as trustee, clients can choose who will serve according to the instructions they provide. Clients may choose a team of advisors and/or a professional trustee. Whomever they choose, it is crucial that the trustee is financially savvy, well-organized and of course, ethical.

Planning Tip:  The trustee of a Special Needs Trust should understand the client objectives and be qualified to invest the assets in a manner most likely to meet those objectives.

Costly Mistake #8: Failing to invite contributions from others to the trust.

A key benefit of creating a Special Needs Trust now is that the beneficiary’s extended family and friends can make gifts to the trust or remember the trust as they plan their own estates. For example, these family members and friends can name the Special Needs Trust as the beneficiary of their own assets in their revocable trust or will, and they can also name the Special Needs Trust as a beneficiary of life insurance or retirement benefits.

Planning Tip:  Creating a Special Needs Trust now allows others, such as grandparents and other family members, to name the trust as the beneficiary of their own estate planning.

Costly Mistake #9: Relying on siblings to use their money for the benefit of a special needs child.

Many clients rely on their other children to provide, from their own inheritances, for a child with special needs. This can be a temporary solution for a brief time, such as during a brief incapacity if their other children are financially secure and have money to spare. However, it is not a solution that will protect a child with special needs after your clients have died or when siblings have their own expenses and financial priorities.

What if an inheriting sibling divorces or loses a lawsuit? His or her spouse (or a judgment creditor) may be entitled to half of it and will likely not care for the child with special needs. What if the sibling dies or becomes incapacitated while the child with special needs is still living? Will his or her heirs care for the child with special needs as thoughtfully and completely as the sibling did?

Siblings of a child with special needs often feel a great responsibility for that child and have felt so all of their lives. When clients provide clear instructions and a helpful structure, they lessen the burden on all their children and support a loving and involved relationship among them.

Planning Tip:  Relying on siblings to care for a special needs beneficiary is a short-term solution at best. A Special Needs Trust ensures that the assets are available for the special needs beneficiary (and not the former spouse or judgment creditor of a sibling) in a manner intended by the client.

Costly Mistake #10: Failing to protect the special needs beneficiary from predators.

An inheritance that funds a special needs trust by will rather than by revocable living trust is in the public record. Predators are particularly attracted to vulnerable beneficiaries, such as the young and those with limited self-protective capacities. By planning with trusts rather than a will, clients decide who has access to the information about the transfer of their property. This protects their special needs child and other family members, who may be serving as trustees, from predators.

Planning Tip:  A Special Needs Trust created outside of a will ensures that information about the inheritance is not in the public record, protecting the special needs beneficiary from predators.


Planning for special needs beneficiaries requires particular care and the participation of all of the clients’ wealth planning advisors. A properly drafted and funded Special Needs Trust can ensure that special needs beneficiaries have sufficient assets to care for them, in a manner intended by their loved ones, throughout the beneficiaries’ lifetime.

To comply with the U.S. Treasury regulations, we must inform you that (i) any U.S. federal tax advice contained in this newsletter was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax advisor based on the taxpayer’s particular circumstances.

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The Continuing Need for Life Insurance

Volume 2, Issue 1

The last issue of our newsletter examined the various educational savings vehicles available to clients, including 529 plans, UGMA/UTMAs, Coverdell Education IRAs and life insurance. Using life insurance as an education savings vehicle prompted several questions about other uses for life insurance. Therefore, this issue of the Wealth Counselor examines some of these other common uses for life insurance, the only asset class that can ensure the completion of proper funding for a myriad of unique planning needs – regardless of the state of the federal estate tax!

Income Replacement
How will my family eat if I die?

Even if the client is not subject to estate tax, life insurance can replace lost income if the client dies unexpectedly (more policies pay out for income replacement than for liquidity to pay estate tax). For example, clients with young children should consider using life insurance to ensure that there are sufficient funds available to pay for child-rearing or college and post-graduate expenses in the event of a parent’s premature death. For these income replacement policies, the estate tax, including the possibility of estate tax repeal, has no significance.

Planning Tip:  Clients should consider life insurance to replace income from the premature death of a breadwinner spouse or parent.

Wealth Creation
What if I die before I build an estate for my family?

Another need for life insurance unaffected by the estate tax is the use of life insurance to create wealth. Examples of this need are families who wish to add to their wealth for future generations or to fund their philanthropic objectives.

Planning Tip:  Consider life insurance to create wealth or additional wealth for the client’s family and future generations.

Wealth Replacement
How can my family receive the full value of my assets?

Traditionally, life insurance has been used to replace wealth lost to the federal estate tax. However, with an increasing federal estate tax exemption (currently $2 million per individual, $4 million per married couple), fewer clients are subject to federal estate tax. Thus, fewer clients need traditional wealth replacement policies. However, many clients have significant other wealth replacement needs.

For example, many clients’ most significant assets are tax-qualified plans (such as IRAs, 401(k)s and pension plans). Because these assets are Income in Respect of a Decedent (IRD), they will be subject to ordinary income tax when distributed to beneficiaries. While we often discuss with clients maximum income tax deferral (“stretch out”), many beneficiaries will deplete these assets quickly, incurring significant income tax. Recognizing this, many clients would benefit from life insurance designed to replace this lost wealth.

In addition to traditional wealth replacement needs, wealthier clients would benefit from wealth replacement for assets transferred to a charitable remainder trust (CRT) or to a charitable lead trust (CLT), which is often used to eliminate estate tax.

Planning Tip:  Consider life insurance for non-traditional wealth replacement purposes, such as to replace income tax paid for significant IRAs and other tax-qualified plans, or where the client has used a charitable lead trust to avoid estate tax.

Planning Unrelated to the Federal Estate Tax
I didn’t know there were so many other situations where only life insurance will assure me my goals will be reached even if I die!

Clients often use life insurance in planning that is wholly unrelated to the estate tax. There is a continuing need for life insurance as a funding vehicle in numerous situations, including:

  • buy-sell planning;
  • key employee coverage;
  • nonqualified deferred compensation;
  • death-benefit-only plans;
  • liquidity to pay debts;
  • liquidity for state death taxes; and
  • inheritance equalization.

Income-Tax-Free Status of Death Benefits
What a difference not paying taxes can make on the amount to which my premiums can grow.

With increasing federal estate tax exemption amounts, there is now an increased emphasis on income tax planning, with a particular emphasis on assets that combine basis step-up with tax-free or tax-deferred growth. Life insurance proceeds paid upon the death of the insured, as well as proceeds attributable to investment appreciation on the cash value portion of the policy, are excluded from gross income. As a result, not only is the death benefit of a life insurance policy tremendous compared to the premiums paid if the insured dies prematurely, in a properly designed policy the death benefit remains quite handsome even if the insured lives past life expectancy.

Planning Tip:  The unique character of life insurance allows a capable and competent life insurance agent to design a product providing excellent results over a long time frame.

Irrevocable Life Insurance Trusts
A little planning can provide enormous tax savings.

Even though the insurance death benefit is not subject to income tax, the life insurance proceeds will likely be included in the client’s gross estate and, therefore, be subject to federal and/or state estate tax absent a properly drafted and maintained Irrevocable Life Insurance Trust (ILIT). As a result, many clients create ILITs for the purpose of owning life insurance to avoid federal and state estate tax on the death proceeds.

Planning Tip:  Use an Irrevocable Life Insurance Trust to purchase, own and be the beneficiary of life insurance to avoid having the death proceeds subject to estate tax. A good lawyer with prompt turnaround of a trust document is a critical component of the planning team.

Planning Flexibility
How can I deal with the uncertainty of estate taxes?
Will I need the extra cash at my death, or not?

The uncertainty surrounding the federal estate tax and the exemption equivalent amount may suggest the use of the most flexible types of cash value policies, such as universal life policies. These policies permit the policy owner to vary the amount of premium payment, the level of death benefit, and the amount of cash value (in exchange for this flexibility, the client may give up the guarantees that the premium will provide a guaranteed death benefit for the life of the policy). No other single asset provides the same degree of planning flexibility. However, it is incumbent on the planning professional to ensure that the product selected fits the needs of the particular client.

Planning Tip:  Permanent life insurance is a unique asset that provides the highest degree of flexibility for changes in the law or changes in the client’s circumstances. The quality of the life insurance agent and the life insurance company he or she selects are among the most important choices a client can make.


Life insurance is the only asset class (other than cash) that a client can remove from his or her gross estate, yet it still provides liquidity (e.g., for federal or state death tax or capital gain tax) or wealth replacement (e.g., to make beneficiaries “whole” for large IRD items like IRAs, 401(k)s, and pension plans) without itself incurring income tax. All other assets removed from the client’s gross estate for estate tax purposes must be sold and the gain realized to net the required amount.

To comply with the U.S. Treasury regulations, we must inform you that (i) any U.S. federal tax advice contained in this newsletter was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax advisor based on the taxpayer’s particular circumstances.

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Understanding Educational Savings Vehicles

Volume 1, Issue 3

The last issue of our newsletter examined the many benefits of 529 Plans, including the income tax and gift and estate tax benefits of these popular educational savings vehicles. There are, however, several other educational savings vehicles that clients should consider; this issue examines some of these other vehicles – and the advantages and disadvantages of each.

Why is saving for education so important?According to the College Board, the average cost of a four-year college or university is increasing at two to three times the rate of inflation. For the 2006-2007 school year, costs average $5,836 per year for an in-state four-year college and $22,218 per year at a private four-year college. Therefore it is no surprise that advisors who understand the options bring significant value to their clients.

Planning Tip:  Saving for college is often the most significant savings goal for adults facing college costs in the future.

UGMA/UTMA Accounts

The simplest form of education savings vehicles, and perhaps the most common, is an account created under the Uniform Gift to Minors Act (UGMA) or, its successor, the Uniform Transfer to Minors Act (UTMA) in the child’s state. While simple and inexpensive, there are considerable disadvantages to UGMA and UTMA accounts.

Most clients’ biggest concern with these accounts is that a gift made to an UGMA or UTMA account vests absolutely in the beneficiary. In other words, neither the custodian nor the donor can change the beneficiary after establishment of the account, and, significantly, the custodian must deliver the balance of the account outright to the beneficiary when he or she reaches the age of majority (18 or 21, as defined by state law). For a beneficiary receiving government benefits, this required outright distribution may cause the beneficiary to lose his or her government assistance upon attainment of majority. Until the beneficiary reaches majority, the custodian has a fiduciary duty to spend the income or principal for the benefit of the minor.

Planning Tip:  UGMA and UTMA accounts are the simplest education savings vehicles, but upon attaining the age of majority, the beneficiary has the absolute right to the account and can spend it as he or she pleases, not limited to education.

Effective May 17, 2006, the “kiddie tax” may also come into play for beneficiaries who are younger than 18 (it previously applied only to beneficiaries younger than 14). With the kiddie tax, if the parents claim as a dependent a child under age 18, all of that child’s unearned income above $1,700 per year (for 2006), including UGMA or UTMA income, will be taxed at the parent’s income tax rate, whether or not the parent is the custodian. For children 18 years and older, the income on assets in a UGMA or UTMA account is generally taxed at the child’s rate, typically much lower than the parents’ rate.

Planning Tip:  The “kiddie tax” applies to UGMA and UTMA accounts if the beneficiary is under 18 and has unearned income greater than $1,700 in 2006. If so, the beneficiary child must complete and attach IRS Form 8615 to his or her income tax return and pay this tax at the parents’ income tax rate.

While a transfer to a minor under UGMA or UTMA constitutes a completed gift for federal gift tax purposes at the time of the transfer, if the donor names himself or herself as custodian of the account and that person dies before the child reaches majority, the UGMA or UTMA account assets will be includible in the donor/custodian’s gross estate for estate tax purposes.

Planning Tip:  A donor should not name himself or herself as custodian of the UGMA or UTMA account to avoid the account assets from being included in the donor’s estate for federal estate tax purposes.

Coverdell Education Savings Accounts (ESAs)

Education Savings Accounts, formerly Education IRAs, were of little significance until passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). EGTRRA increased the maximum annual contribution limit from $500 to $2,000 per beneficiary, while also increasing the AGI limits for maximum contributions to these accounts. Significantly, as a result of EGTRRA, a donor can make contributions to an ESA and a College Savings Plan for the same child in the same year. Moreover, while 529 Plans are limited to paying for higher education, ESAs can be used to fund primary and secondary school.

Planning Tip:  Clients should consider contributions to both 529 plans and Education Savings Accounts for the same beneficiary in the same year, to cover educational expenses of primary through higher education.

Life Insurance

The inside cash buildup of permanent life insurance policies such as whole life, universal life, and variable life offer another opportunity to accumulate funds that can be used for educational expenses. This strategy usually makes sense when the client has an already existing need for life insurance (such as protecting a family’s income in case of death). A very simplified explanation of this technique is for the client to pay into the life insurance policy more than is needed to support the policy through the life of the client. These extra funds accumulate inside the life insurance policy on an income tax free basis and can be accessed by the client when his or her children reach college age (or if there is an emergency or other need).

Flexible premium universal life and variable universal life policies typically include the option to take partial withdrawals from, or loans against, the cash value of the policy (some policies even have a “wash” loan feature that makes loans even more attractive). When the time comes, the client will either withdraw or borrow the necessary college funding from the accumulated cash value of the life policy.

Withdrawals from a cash value life insurance policy (other than a modified endowment contract) are not subject to income tax until the cumulative withdrawals exceed the cost basis, or the aggregate premium payments on the policy. Loans from such policies are likewise not taxable at the time of the loan nor are they taxable if they are repaid from the death benefits when the policy “matures.”

Careful planning is needed to determine the premium structure, the best method to access the cash buildup in the life insurance policy, and to make sure the viability of the policy is not endangered. Usually making withdrawals to basis first and then borrowing from the cash value is the preferred method to access the cash value of a policy having any loans repaid at death from the income tax free proceeds of the life policy.

An added benefit of this technique is that if the client dies prematurely the death benefit from the life policy becomes available to pay for college or other family expenses.

As with most sophisticated planning, there may be traps for the unwary. For example, there can be very negative tax effects if the plan is not designed properly or the policy doesn’t perform as expected and there isn’t an adequate cushion so that the life policy lapses before death. And of course there are estate tax considerations to be taken into account. That said, in the hands of an experienced life insurance professional, this technique can be quite beneficial and allow for several potential needs to be met with one planning device.

Planning Tip:  Clients should consult a knowledgeable and experienced life insurance professional and tax counsel when considering the use of permanent insurance to fund higher education or provide additional cash benefits in the event of a bread winner parent’s premature death.

Demand Trusts

Demand rights convert what would otherwise be a gift of a future interest to a gift of a present interest, thereby qualifying the gift for the $12,000 gift tax annual exclusion. To qualify, the trustee must adhere to the strict procedure requirements for Crummey trusts: the trustee must immediately notify the minor beneficiary through the child’s legal guardian that the donor has made a gift to the trust. The beneficiary then has a specified period of time (typically 30 days) to demand a distribution from the trust in the amount of the gift. If the specified number of days lapses, the gift will stay inside the trust and continue to be governed by the trust terms.

This demand right allows the trust maker to make contributions of up to $12,000 per year, free of gift tax and possibly generation-skipping transfer (GST) tax.

Demand trusts remove the trust assets from the trust maker’s estate, even if the trust maker acts as trustee, as long as the trust instrument limits the trustee’s discretion to make distributions to “ascertainable standards”; i.e., the education, health, maintenance and support of the beneficiary (and provided the trust instrument does not give the trust maker too much control over the trust). If a demand right beneficiary dies during the time that a demand right is outstanding, the amount of the outstanding demand right is includible in the beneficiary’s gross estate for estate tax purposes.

Planning Tip:  Demand trusts are a flexible savings vehicle for education expenses and other expenses set forth by the trust maker in the trust agreement. While typically funded with life insurance, the trust maker can also fund a demand trust with other assets.

Direct Payments to an Educational Institution Another educational funding option is for the donor to make transfers directly to an educational institution. Under the Internal Revenue Code, these transfers are not subject to gift, estate, or GST tax. Therefore, prepaid tuition payments by a donor can achieve a significant estate tax reduction. Direct payments are not deductible as a charitable contribution for income tax purposes, however, because they are made for a particular student.

Since only direct payments to the educational institution qualify, it is highly recommended that the donor make contributions to the school while the child is presently enrolled. If the donor wishes to make advance payments for numerous years’ tuition, the donor (and the parent(s) if the donor is the student’s grandparent) should enter into a written agreement with the educational institution providing that (1) the donor and/or parent will pay any future tuition increases; (2) the prepayments are non-refundable; and (3) the prepayment does not afford the child any additional rights or privileges over any other student.

Impact on Financial Aid

For some clients, the impact on needs-based financial aid may play a role in the selection process, because assets placed in the student’s name may reduce (or even eliminate) the amount of otherwise available financial aid. The needs based financial aid rules state that 5% of the parent’s assets (special rules determine this amount for financial aid purposes) and 35% of the child’s assets are available for education. Therefore, shifting assets from the parent to the student through the use of UGMA/UTMAs, ESAs, and 529 plan distributions may reduce the student’s needs based financial aid. Alternatively, life insurance should not impact needs based aid, whereas a demand trust will depend upon the child’s access through the trust terms.

Planning Tip:  Avoid shifting assets to the child if the client is concerned about the potential impact on needs based financial aid.


There are numerous education savings options. Most often, the “right” choice for the client will depend upon his or her unique goals and objectives. It is therefore incumbent upon all wealth planning professionals to help the client determine those objectives and advise accordingly.

To comply with the U.S. Treasury regulations, we must inform you that (i) any U.S. federal tax advice contained in this newsletter was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax advisor based on the taxpayer’s particular circumstances.

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529 Plan Benefits Made Permanent by the Pension Protection Act

Volume 1, Issue 2

Whether your client is a parent with future educational obligations for young ones, or perhaps a loving aunt, uncle, grandparent, or stepparent, now more than ever 529 plans are an attractive tool for the escalating costs of education, as well as for income and estate planning purposes. This is because one of the hidden gems of the new Pension Protection Act of 2006 (signed into law on August 17, 2006) is a provision that makes permanent the income tax-free growth of Section 529 plans used for qualified higher education expenses. Prior to this new law, these provisions would have expired December 31, 2010.

Planning Tip:  The new Pension Protection Act makes permanent the income tax-free growth of 529 plans, but only for withdrawals used for qualified higher education expenses. Funds used for other expenses are tax deferred (like an IRA) and subject to a 10% penalty.

Most wealth planning professionals (and clients for that matter) understand the value of investing in 529 plans. 529 plans are by far the most popular college savings vehicle, but they’ve just become even more popular. According to a recent survey, 54% of parents with young children who do not currently own a 529 account are more likely to open one now, due to the new law, and 36% who already own a 529 plan say they are now more likely to increase the amount they contribute to existing plans. And another recent survey confirmed that older clients may want to learn more about college savings.

Income Tax Benefits

While many clients understand the educational savings benefits, many do not understand the benefits of investing in 529 plans for income tax purposes. Just like with an IRA, the power of tax-deferred growth makes 529 plans worthwhile even if not used for educational expenses. The ability to frontload up to five years of annual exclusion gifts, or $60,000 per beneficiary ($120,000 per beneficiary for married couples), without paying gift tax creates the ability to grow a significant amount of money tax free. In addition, many states offer residents a state income tax deduction for an investment in their state’s 529 plan. Planning Tip: Clients should consider an investment in a 529 plan even if it is not anticipated that the funds will be used for educational purposes. The income tax benefits alone of 529 plans make these very worthwhile investments.

Estate Planning Tax Benefits

529 plans are unique in that you can invest in a 529 plan, retain absolute control over the assets, and yet remove those assets from your estate for estate tax purposes. This type of control typically means that the asset would be subject to estate tax at a 46% rate (in 2006) at death, but not with a 529 plan. Thus, clients can invest up to $60,000 per beneficiary ($120,000 per beneficiary for married couples) without paying gift tax and, if the client lives for at least five years, all of these assets will not be subject to estate tax. More importantly for many clients, a 529 plan allows them to use the 529 plan assets in a financial emergency.

Planning Tip:  Clients should also consider 529 plans for estate planning purposes to remove significant wealth from the estate tax while retaining the ability to use the assets in a financial emergency.

Educational Trusts

Many 529 plans permit a trust to be the owner and beneficiary of accounts set up under that state’s plan. A 529 plan combined with an Educational Trust may provide more flexibility to ensure that the 529 meets the client’s objectives by, for example, moving assets between siblings or providing a smooth transition should the client become incapacitated or die.

This combination of 529 plans and specially designed trusts can also provide divorce and creditor protections, even for those states’ 529 plans that do not provide their own asset protection; for example, to ensure that the 529 plan’s assets do not end up in the hands of a former son-in-law or daughter-in-law. And the client still retains the ability to use the funds in a financial emergency.

Planning Tip:  Consider combining 529 plans with Educational Trusts to provide the greatest flexibility and to ensure that the 529 plan assets meet each client’s particular planning objectives.


Now more than ever, clients should consider 529 plans for educational savings, income tax benefits and estate tax benefits; and when combined with a carefully-crafted Educational Trust, they will provide added flexibility to control this asset and to ensure that it meets the client’s planning objectives.

To comply with the U.S. Treasury regulations, we must inform you that (i) any U.S. federal tax advice contained in this newsletter was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax advisor based on the taxpayer’s particular circumstances.

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The Pension Protection Act: New Opportunities for Retirement Planning

Volume 1, Issue 1

The new Pension Protection Act of 2006 (signed into law on August 17, 2006) creates significant planning opportunities for advisors and their clients who understand it. This newsletter focuses on two key provisions: (1) non-spousal rollovers from a qualified plan to an inherited IRA and (2) charitable contributions of IRAs during lifetime.

Non-Spousal Rollovers from Qualified Plans

In the past, only a surviving spouse could roll over a qualified plan (for example, a 401(k)) to an IRA after the plan owner’s death. Once rolled over, it is as if the surviving spouse created the IRAÑhe or she can defer required minimum distributions from the IRA until reaching age 70 1/2 and can withdraw these required minimum distributions over his or her lifetime.

Planning Tip:  The new law does not impact spousal rollovers; a spouse can still rollover a qualified plan to his or her own IRA after the death of the owner.

Alternatively, a beneficiary other than a surviving spouse (for example, a child or unmarried partner) has been forced to withdraw the qualified plan in full – and pay income tax on this amount – over the period set forth in the plan agreement, typically within one to five years of the plan owner’s death. Thus, a non-spouse beneficiary could not defer income tax by “stretching out” distributions over his or her life expectancy.

Beginning January 1, 2007, a non-spouse beneficiary can roll over a qualified plan to an “Inherited IRA” after the plan owner’s death. If the owner names a trust as beneficiary of the qualified plan, the trustee of that trust can roll over the qualified plan to an inherited IRA for the benefit of the trust beneficiary.

Planning Tip:  Clients who name a trust as designated beneficiary can protect the assets from creditors (including former spouses of the beneficiary) and spendthrift beneficiaries, who often withdraw far more than the required minimum distributions. Naming a trust also allows the owner’s financial advisor to continue to manage the assets as the owner desired.

With an Inherited IRA, a non-spouse beneficiary can use his or her own life expectancy to determine required minimum distributions. This significantly reduces the amount that the beneficiary must withdraw each year, thereby deferring income tax and allowing the account balance to continue to grow income tax free.

Planning Tip:  A non-spouse beneficiary must begin taking required minimum distributions from the Inherited IRA by December 31st of the year following the year of the owner’s death. This is different from a spousal rollover, where the surviving spouse can defer required minimum distributions until attaining 70 1/2.

A rollover to a non-spouse beneficiary must be directly from the trustee of the qualified plan to the trustee of the Inherited IRA (a trustee-to-trustee transfer). In addition, and unlike a spousal rollover, the IRA must remain in the name of the deceased owner.

Planning Tip:  Avoid re-titling the qualified plan in the name of the non-spouse beneficiary. Also avoid transferring the qualified plan to an existing IRA in the non-spouse beneficiary’s name. Both constitute a taxable distribution of the entire account. The Inherited IRA should be titled like this: Susan Participant, deceased, IRA f/b/o Emily Participant (beneficiary).
Planning Tip:  Any distribution to a non-spouse beneficiary is a taxable distribution, subject to income tax. Therefore, the check should be made payable directly to the Inherited IRA.

Until January 1, 2007, a non-spouse beneficiary must continue to use the payout schedule dictated by the qualified plan agreement. Thus, if the plan agreement provides that all funds must be distributed within three years of the owner’s death, the beneficiary must withdraw, and therefore pay income tax on, the entire plan balance within three years, thereby eliminating potentially significant growth through income tax deferral.

Planning Tip:  If possible, delay post-death distributions from a qualified plan to a non-spouse beneficiary until after December 31, 2006 to take advantage of these new provisions.


On October 1, 2006, Susan Participant dies having named a trust for her daughter Emily’s benefit as the death beneficiary with her 401(k) plan. Anytime after December 31, 2006, the trustee of Emily’s trust can request a trustee-to-trustee transfer of the 401(k) to an inherited IRA for Emily’s trust’s benefit, using Emily’s life expectancy to determine the required minimum distributions from the inherited IRA.

Clients Impacted by This Change

All clients with qualified plans and clients named as the beneficiary of a qualified plan will potentially benefit from this new provision.

Charitable Contribution of IRA During Lifetime

In 2006 and 2007 only, a taxpayer who is at least 70 1/2 years old can contribute to charity up to $100,000 per year from one or more Individual Retirement Accounts (IRAs).

Planning Tip:  Distributions from a SEP IRA, SIMPLE IRA or qualified plan do not qualify because they are not distributions from an IRA. Consider rolling out qualified plan assets into an IRA where appropriate to take advantage of this opportunity.

If the contribution is made by direct transfer from the IRA custodian to a “public” charity, the taxpayer need not report the distribution as taxable income. In other words, unlike a typical IRA distribution, the distribution will not appear as taxable income on the taxpayer’s income tax return. Because the distribution does not appear as income, the taxpayer does not get an offsetting charitable income tax deduction to reduce the income created by the IRA distribution.

Planning Tip:  The check must be made payable to the charity. If the check is made payable to the IRA owner who endorses it to the charity, the owner must report the distribution as taxable income.
Planning Tip:  Public charities include religious organization, schools, etc. Unfortunately, Donor Advised Funds, Supporting Organizations and Charitable Remainder Trusts are not public charities, and therefore distributions to these types of charities do not qualify.

Significantly, charitable contributions that meet these requirements satisfy the taxpayer’s required minimum distributions for the year of distribution.

Clients Impacted by This Change

There are two critical questions: (1) Does the client have IRAs from which they can make direct contributions to charity or, alternatively, can the client roll out of a qualified plan into an IRA; and (2) Is the client currently making or contemplating charitable gifts. Consider the following classes of clients who will benefit from this provision.

  1. Clients Who Claim the Standard Federal Income Tax Deduction
    For clients who do not itemize, this new law provides the equivalent of an unlimited federal charitable income tax deduction for up to $100,000 of the charitable gifts that they make from an IRA.
  2. Clients Who Would Lose Phased-Out Deductions with Increased Income
    Under the new law, a direct contribution of an IRA up to $100,000 does not increase the taxpayer’s Adjustable Gross Income (AGI). Correspondingly, it does not impact other deductions.
  3. Clients Who Are Subject to the 50% Limitation on AGI
    A direct contribution to charity of up to $100,000 is not subject to the typical 50% of AGI cap for cash contributions to a public charity.
  4. Clients Who Live in States That Do Not Permit State Income Tax Charitable Deductions
    For clients in Indiana, Michigan, New Jersey, Ohio and Massachusetts, direct contributions from IRAs will result in the highest possible net state tax savings.

To comply with the U.S. Treasury regulations, we must inform you that (i) any U.S. federal tax advice contained in this newsletter was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax advisor based on the taxpayer’s particular circumstances.

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