Feel Secure with Education Plan Protection

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Physician's Money Digest, September 2005, Volume 12, Issue 13

Prepaid tuition plans such asthe 529 plan and the CoverdellEducation Savings Accounts(ESAs) now receivefederal protection in bankruptcy.This is really great news becauseif you were to end up in a bad financialsituation, two things you would definitelywant to protect are your retirementsavings and education savings foryour children—one protects yourretirement years while the other protectsyour children's future.

529 Plans

If you are concerned with both fundingyour child's college expenses andasset protection, the 529 plan is anexcellent tool. First, you can put a lot ofmoney in these plans. For example, youcan invest up to $11,000 per child,$22,000 if you are married. If you wantto put in more money, the law allowsyou to contribute up to 5 years worth ofannual gifts at one time. This meansthat you could contribute up to$55,000 per child or $110,000 per childif you are married.

These funds will grow tax-deferredand they are tax-free when withdrawalsare made to pay for qualified collegeeducation expenses. Also, you controlthe money, not your child. If you havemoney left over after paying your child'scollege expenses, you can use it foranother child, grandchild, niece, ornephew. You can even write a checkback to yourself, although you wouldowe taxes on your gains plus a 10%federal penalty. There are no restrictionson who can contribute to a 529 plan.

Coverdell ESAs

For a given beneficiary, a total of$2000 may be contributed each year ona nondeductible basis to an ESA. Thefunds grow tax-deferred and are tax-freewhen used to pay for qualified educationexpenses. What is particularlyattractive about ESAs is that the fundscan be used for either private or publicschools and you can use the funds forelementary, secondary, and higher educationexpenses. However, there are anumber of restrictions.

To be eligible to contribute the full$2000, your modified adjusted grossincome must be less than $95,000, or$190,000 for joint filers. There is a contributionphase-out for modified adjustedgross income between $95,000 and$110,000, or $190,000 and $220,000for joint filers. Contributions to anESA cannot exceed $2000 per beneficiaryno matter who contributes. Thisrequires that family members communicatesince excess contributionsare subject to penalties.

Unlike the 529 plan, you must makecertain your agreement allows you totransfer funds to another beneficiary. Atage 30, any remaining balances in anESA must be paid out to the beneficiarywith gains subject to income taxes plusa 10% federal penalty.

Creditor Exemption

For either 529 plans or ESAs to qualifyfor creditor exemption, several testsmust be passed. The beneficiary musthave been a child, stepchild, grandchild,or stepgrandchild in the year thedeposits were made. Also, the fundsmust have been deposited more than 1year in advance of filing for bankruptcy.Furthermore, during the 720 daysbefore filing for bankruptcy only thefirst $5000 per beneficiary is protected.

Obviously, these restrictions requirethat you do some preplanning. However,creditor concerns aside, these areexcellent tools for funding your child'seducation. If you are worried aboutcreditors, you now have two reasons toconsider the 529 plan and ESA.

Stewart H. Welch III, CFP

®, AEP, is the

founder of the Welch Group, LLC, which specializes

in providing fee-only wealth management

services to affluent retirees and

health care professionals throughout the

United States. He is the coauthor of J.K. Lasser's New Rules

for Estate and Tax Planning (John Wiley & Sons, Inc; 2001).

He welcomes questions or comments at 800-709-7100 or

visit www.welchgroup.com. This article was reprinted with

permission from the Birmingham Post Herald.