Saving for College Plans

Posted on February 15th, 2010 in Educational Expenses, Newsletter Articles, Taxes by wayne

It is expected that taxes will soon rise.  It is also fairly certain that the cost of a college education for our children or grandchildren will continue to rise faster than the annual rate of inflation.  Let’s look at some of the ways that you can save taxes while saving for your children’s or grandchildren’s college education.

You may be aware of the Qualified State Tuition Program, commonly called a Section 529 College Savings Plan.  With the 529 College Savings Plan you can provide a fund for each child.  Contributions are treated as gifts to the person for whom the plan is established and receive the annual gift tax exclusion of $13,000.  A couple may double this gift amount to $26,000.  A unique attribute of the 529 College Savings Plan is the ability to provide up to five times the annual federal gift tax exclusion amount in a single year.  This allows a single gift of up to $130,000 for each child.

529 College Savings Plan contributions are not tax deductible.  However, all interest and appreciation of the plan’s assets grow tax free until withdrawn.   As long as funds are withdrawn to pay for qualified higher education expenses, the withdrawals are also tax free.  If a designated beneficiary does not use their 529 funds, the donor you may change the beneficiary to a different person, including themselves.  However, if withdrawn funds are not used for higher education expenses, a ten percent penalty plus taxes on all of the funds growth and income will be applied to the withdrawal.

The Coverdell Education Savings Account (ESA) is a less know college savings plan.  Tax-wise, the Coverdell ESA behaves the same as a 529 plan.  However, Coverdell ESAs allow only a $2,000 annual contribution for each beneficiary.  On the positive side, a Coverdell ESA can be set up similar to a Roth IRA providing the “responsible party” with virtually unlimited investment options.  As long as the beneficiary has not reached age 30, the “responsible party” for the Coverdell ESA may change the beneficiary to another person under age 30.

When you purchase EE and I Savings Bonds, they may be redeemed tax free when the bond owner, their spouse or other dependents use these funds to pay for college tuition and fees.  However, due to income phase outs restrictions, full deductibility is lost when a couple has taxable earning above $104,900.

You may also withdraw funds from an individual retirement account, before age of 59 ½, to pay for any family member’s qualified post-secondary education expenses.  The proceeds will be treated as a normal IRA withdrawal with the 10% early withdrawal penalty waived.  .

The Hope Scholarship Credit, now called the American Opportunity Tax Credit (AOC), allows a parent to claim up to a $2,500 annual tax credit for a dependent’s college tuition and mandatory fees.  This tax credit will “phase out” for couples earning above $160,000 per year.  Since this is a tax credit, the full amount (up to $2,500) can be deducted from taxes owed.

The Lifetime Learning Credit can help pay for your own, your spouse, or your children’s education.  You may claim a tax credit of twenty percent of up to $10,000 in combined tuition and mandatory fees for anyone (and everyone) in your family.  Like the AOC, the Lifetime Learning Credit is a tax credit, lowering taxes owed up to $2,000.

The Lifetime Learning Credit’s “phase out” begins at $100,000 per year for joint filers.  Since you cannot claim both the AOC and the Lifetime Learning Credit in the same year, if you qualify for the full AOC, you cannot use this credit.  However, the Lifetime Learning Credit can be used for part time students and for courses to improve your job skill, while the AOC only applies to full time college students.

College expenses will continue to rise.  It is more critical than ever for families to begin early planning to meet these high expenses.  As taxes rise, the tax savings from these programs will become an ever more important piece of your child’s or grandchild’s college education planning.

Self Employed Retirement Plans

Posted on February 15th, 2010 in Newsletter Articles, Retirement Planning, Taxes by wayne

A recent Wall Street Journal article stated that, with unemployment hovering at 10 percent, approximately 20-23 percent of all US workers are now self-employed.  If you have self-employment income or own a small company, it is important to be aware of the tax saving options available through retirement plans.

We will consider four retirement plan options available for the self-employed and small business owner.  Each of the plans provides immediate tax savings on the retirement funds contributed.  The retirement funds also receive tax deferred growth until the funds are withdrawn.

The simplest retirement plan is the IRA.  If you have no company retirement plan and are under age 70 ½ , you may contribute up to $5,000 ($6,000 if you are over age 50) annually to a traditional IRA.  If your taxable income is below $166,000, your spouse may contribute the same amount, if they have no company retirement plan.  This contribution may occur even if your spouse receives no income.  There are no requirements to file any company paperwork with an IRA.  As long as your earned income exceeds your IRA contributions, you may continue IRA contributions until age 70 ½ .

The easiest company retirement plan, for a self employed individual, is the SEP IRA.  Your annual contribution to a SEP IRA is limited to the lesser of 25 percent of your W2 compensation or $49,000 annually.  SEP IRA contributions are tax deductible for the employer and excluded from the employee’s income.  These plans are immediately vested and must apply equally to all employees over age 20, who have been employed for at least three of the past five years.

For high-income, self-employed individuals, a SEP IRA is often the best choice for a company retirement plan.  If your income is below $50,000 or if you expect to have employees, the SEP IRA may not be your best option, as a SEP IRA requires that you provide the same percentage salary contribution for all of your qualified employees.

If your self-employment income is less than $50,000 or if you have employees, the SIMPLE-IRA is worth consideration.  SIMPLE stands for Savings Incentive Match Plan for Employees.  While these plans allow for up to 100 employees, most SIMPLE-IRA plans are used in smaller companies, including single employee companies.

With a SIMPLE-IRA you may contribute $11,500 ($14,000 if age 50 or over) annually.  Additionally, the company pays an employee matching amount of up to 3% for each employee that makes a SIMPLE IRA contribution.  If you are over age 50 and make $100,000 per year, your total contribution could be $17,000.  A SIMPLE-IRA requires that your company submits a (simple) application to the custodial firm.  Employees typically have the same investment options as they would with an IRA or a SEP IRA.

If you are self-employed and earn $100,000 per year or more, you can maximize your tax deferred contributions to with a Solo 401(k) retirement plan.  Solo 401(k) plans are typically established through mutual fund companies, insurance companies and discount brokerage houses.  These plans will have a set up fee, an annual administration fee, and other fees associated with investments and trading.

With a Solo 401(k) plan, you may contribute $16,500 of your W2 income ($22,000 if age 50 or older) plus twenty percent of your net corporate profits, up to a maximum of $49,000 ($54,500 if over age 50).  As an example, if you are over age 50 and your company produces annual income of $120,000, you may contribute $22,000 plus twenty percent of your net income, for a total of approximately $40,000 in contributions, to a Solo 401(k) plan.

For the self-employed or small business owner, there is no “on size fits all” solution to retirement plans.  The best plan will depend upon your annual income as well as the amount of tax deferred savings you desire to contribute each year.  If it is unclear which plan will be the best for you, feel free to contact me or call your financial advisor to determine which retirement plan best fits your requirements.  Regardless of which plan you choose, it is important to start saving now for your retirement, to help insure that you will have financial abundance throughout your retirement.