Irresponsible Advice You Shouldn't Give Clients

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I try not to read very many articles that simply offer someone’s opinion. However, there are some that give such bad advice, I can’t ignore them.

One example was a piece stating that a trust is better than a Section 529 plan. While the author backed up the claim with specific reasons, the premise itself is a mistake. Let me explain in more detail. 

There are three main ways to transfer money to minors:  a 529 plan, a Uniform Transfers to Minors Act (UTMA) account or an irrevocable trust.

An UTMA account is very easy to set up and use. The custodian of the account (typically the parent of the minor child) is allowed to use it any way they see fit. They also have full control over how the assets are invested. At age 21, the minor gains complete access to the assets. This sometimes results in disaster: For instance, some young adults decide to use the money to buy a sports car or to fuel a nasty drug or alcohol problem.    

A Section 529 plan is tax advantaged. The monies that are contributed to the plan are earmarked for educational purposes, such as college or private school. The assets grow tax free, and, provided they are used for education, are not taxable when they are removed from the 529.

Here are some qualifying expenses:

  • Tuition and fees
  • Book and supplies          
  • Computers and related equipment and services (e.g., internet access)
  • Room and board
  • Special needs equipment

In addition, as of 2018, you can front-load your contributions to a 529 plan by putting money into it (within the annual gifting limitations) over a period of five years. So in 2018, you could put $75,000 into the plan if you were single or $150,000 if you were married and you and your spouse elected to split the gifts. Finally, the individual who sets up the plan owns it, and the child is the beneficiary. If the amounts are not used by the latter, they can be transferred to another family member, such as a first cousin.

A trust is a different animal. It is created when a grantor (the person making the trust), a trustee (the person controlling the assets) and a beneficiary (the person inheriting the assets) create a legal document. There are revocable trusts, which can be changed (these are known as grantor trusts for tax reasons) and irrevocable ones, which cannot be altered.

The latter provide asset protection for the corpus (assets contributed to the trust) and remove them from a person’s taxable estate. Irrevocable trusts are taxable to the beneficiary on the money the corpus makes through investing or any other means. They have their uses, but they are not superior when it comes to transferring money to a minor. Here’s why.

First of all, you have created a taxable situation for the beneficiary. Any monies that are made on the corpus are taxable to this individual. Secondly, you need to file a separate tax return just for this type of trust. Finally, no matter what happens, you can’t change the account.

As you can see, the article’s advice is just plain irresponsible counsel to give a client. A 529 plan is the best vehicle to save for college.

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About Craig W. Smalley, EA

Craig Smalley

Craig W. Smalley, MST, EA, has been in practice since 1994. He has been admitted to practice before the IRS as an enrolled agent and has a master's in taxation. He is well-versed in US tax law and US Tax Court cases. He specializes in taxation, entity structuring and restructuring, corporations, partnerships, and individual taxation, as well as representation before the IRS regarding negotiations, audits, and appeals. In his many years of practice, he has been exposed to a variety of businesses and has an excellent knowledge of most industries. He is the CEO and co-founder of CWSEAPA PLLC and Tax Crisis Center LLC; both business have locations in Florida, Delaware, and Nevada. Craig is the current Google small business accounting advisor for the Google Small Business Community. He is a contributor to AccountingWEB and Accounting Today, and has had 12 books published on various topics in taxation. His articles have also been featured in the Chicago Tribune, New York Times, Yahoo Finance, Nasdaq, and several other newspapers, periodicals, and magazines. He has been interviewed and been a featured guest on many radio shows and podcasts. Finally, he is the co-host of Tax Avoidance is Legal, which is a nationally broadcast weekly Internet radio show.

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Feb 5th 2019 00:23

Very informative. I have to wonder if the article recommending trusts was written by a lawyer who sets up trusts and files the returns. The need to file returns creates an annual income stream for the preparer, so not exactly impartial advice.

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