Bt Investments Blog

One nice plus is that with both of these accounts you can switch the beneficiaries among other members of your family. That includes the beneficiary’s spouse, child, grandchild, stepchild, sibling, step-sibling, parent, grand-parent, stepparent, niece, nephew, son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, sister-in-law—or any of these relatives’ spouses—as well as any first cousins.

This is also nice in case one child doesn’t use all their savings,  You can then just transfer to the other child.

What about Gift Taxes?

When you contribute money to an account in another person’s name, your contribution is considered a gift. You can give away up to $13,000 per year—or $65,000 once in five years to a 529 savings plan (as of 2010)—before you may have to file a gift tax report and eventually pay gift taxes. But gift taxes apply per donor and per beneficiary. So, in one year you could contribute $13,000 to one child’s 529 account, and then contribute another $13,000 to another child’s account without owing gift taxes. Or, you and other relatives could each contribute $13,000 a year to one child’s account. Remember, though, that ESAs limit contributions to $2,000 a year.

Differences between Education Savings Accounts and 529 Plans

The ESA and 529 have some key differences.  Here are the key three:

• In the ESA, the total contribution for any one beneficiary can be no more than $2,000 a year.  You can contribute $2,000 to an eligible beneficiary’s ESA if you meet the adjusted gross income (AGI) requirements. That is, your AGI must be less than $95,000 if you’re single—or $190,000 if you’re married and filing a joint return.  The 529 plan has no maximum contribution limit.
• In an ESA, as your AGI increases above these levels, the amount you can give is phased out until your AGI reaches $110,000—or $220,000 if you’re married—at which point you are no longer eligible to contribute.  The 529 plans has no income restriction.
• Anyone who’s younger than 18 when an ESA is opened and younger than 30 when the money is spent is eligible to be a beneficiary.  In a 529 plan, there are no age restrictions.

Early Distributions From Retirement Plans

An early distribution from an Individual Retirement Arrangement (IRA) or a qualified retirement plan need not be a 'taxing' experience. Fortunately, there are exceptions to early distributions.

Any payment that you receive from your IRA or qualified retirement plan before you reach age 59½ is normally called an 'early' or 'premature' distribution. As such, these funds are subject to an additional 10 percent tax. But there are a number of exceptions to the age 59½ rule that you should investigate if you make such a withdrawal. Some of these exceptions apply only to IRAs, some only to qualified retirement plans, and some to both. IRS Publications 575, Pensions and Annuities, and 590, Individual Retirement Arrangements (IRAs), have details.

In addition to the 10 percent tax on early distributions, you will add to your regular taxable income any distributions attributable to 'elective deferrals' that you contributed from your pay, your employer's contribution and any income earned on all contributions to the account. If you made any nondeductible contributions, their portion of the distribution is not taxed, since you've already paid tax on this amount.

There is a way to avoid paying any tax on early distributions, however. It is called a 'rollover.' Generally, a rollover is a tax-free transfer of cash or other assets from an IRA or qualified retirement plan to an eligible retirement plan. An eligible retirement plan is a traditional IRA, a qualified retirement plan, or a qualified annuity plan. You must complete the rollover within 60 days of when you received the distribution. The amount you roll over is generally taxed when the new plan pays you or your beneficiary.

If the early distribution from an employer's plan is paid directly to you, your plan administrator will normally withhold income tax at a 20 percent rate. If you roll over the distribution to a new plan, you must replace that 20 percent of the funds that were withheld and deposit that amount in the new plan or you will owe taxes on that amount. To avoid the inconvenience of this withholding, you can have your old plan's administrator transfer the rollover amount directly to the new plan or a traditional IRA.

All early distributions must be reported to the IRS. You will report tax-free rollovers on lines 15a and 16a of Form 1040 along with any taxable distributions, but you will enter on line 15b or 16b only the taxable amounts you don't roll over.

Early distributions from retirement plans can involve complex tax issues. Make sure you understand the issues or get competent tax advice.

About the author: Richard Chapo is CEO of Business Tax Recovery - Obtaining tax refunds for small businesses for overpaid taxes. Discovery tax strategies and deductions in our tax articles section.