EGTRRA Provisions Affecting PFP

Author:
Randi Grant, CPA, CFP, PFS
Berkowitz, Dick, Pollack & Brant
Miami, FL

Editor's note: Randi Grant is a member of the AICPA PFP Executive Committee. For information about this column, contact Ms. Grant at rgrant@bdpb.com.

A financial planner's mission is to help clients identify and achieve their goals. This includes tax planning, retirement planning, estate planning and risk management. Last summer, Congress enacted the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which gave financial planners several new options and possibilities to consider for their clients. While the EGTRRA repeals certain key provisions in 2010, financial planners should apply the Code as it reads today. Experience indicates that the only thing certain about tax legislation is uncertainty. (Congress is already considering newer tax legislation, which might be enacted before this column appears.) Given this, diligent monitoring is essential to good financial planning. Planners should review and probably revise all existing financial plans, as significant changes might render existing plans obsolete.

Education Planning

Sec. 529 plans. Qualified tuition plans under Sec. 529 are attracting considerable interest. They are a powerful planning opportunity—plan assets grow tax-free and distributions are tax-free, provided taxpayers use the distributions to pay for qualified higher education expenses. Taxpayers can claim Hope or Lifetime Learning credits for the same year in which they make distributions from Sec. 529 plans, as long as they do not use the distributions for the same expenses for which they claim the credit. The EGTRRA expands the definition of family member to include first cousins, and eases the tax-free rollover rules. In effect, this gives grandparents more incentive to fund Sec. 529 plans.

Brokerage firms and state legislatures have been quick to provide a myriad of investment options, creating adviser-class shares for which a financial planner (with the appropriate securities licenses) may be compensated, legislating new plans and increasing funding limits.

In accordance with state law, many clients have established Uniform Gift to Minors Act (UGMA) accounts to fund education. Existing UGMA accounts should be used to pay for elementary and secondary school education, summer camp, vacations and other allowable expenses; taxpayers can, in turn, use the funds that were earmarked for these expenses to fund a Sec. 529 plan.

Alternatively, certain plans allow plan participants or account owners to act as an UGMA account. Financial planners should be mindful, however, of a beneficiary's rights to the account on reaching majority. Certain plans also allow trusts as participants; thus, purchasing a Sec. 529 plan in the name of a child or grandchild's trust can accelerate funding (given the tax-free accumulation and distribution features).

A unique feature of Sec. 529 plans allows an individual to establish an account while at the same time retaining ownership and control of the account. However, contributions to the account are considered completed gifts and would not be included in the participant's estate. An exception occurs when a participant makes a special election to accelerate funding by contributing $50,000 to an account, qualifying the gift to be disbursed over a five-year period. If the participant dies within the five-year period, a prorated portion of the gift is included in the participant's estate. In plans with specific college-funding goals, the tax savings should result in an increase in assets available for other goals.

Education IRAs. The contribution limit for Education IRAs increased to $2,000 per year, beginning in 2002, which enhanced their attractiveness as a financial planner's tool. The deadline for making contributions was extended to April 15 of the following tax year. Qualified expenses include most costs related directly to elementary and secondary school tuition, as well as religious school tuition. The contribution phaseout ranges increased from $190,000 ($220,000 for joint filers). Corporations and other entities may contribute to Education IRAs; however, the contribution is taxable income to the employee.

Retirement Planning

IRAs. IRA contribution limits increase to $3,000 in 2002–2004, to $4,000 in 2005–2007, and to $5,000 beginning in 2008. Individuals age 50 and over can contribute an additional $500 in 2002–2005 and an additional $1,000 thereafter. The increase in contribution limits is an attractive feature of IRAs; in some instances, funds could accumulate up to three times as fast as under old law.

Qualified Plans. Qualified plans are also more attractive with increasing contribution and benefit limits, as well as liberalized top-heavy rules. Under the EGTRRA, S shareholders can borrow from their qualified plans. This feature makes an S election a good idea for shareholders who have outstanding loans from their qualified plans. Employers who avoided plans because of the top-heavy rules may wish to revisit the topic.

Estate Planning

Documentation. With the estate tax reduction being phased in through 2009, repealed in 2010 and reinstated in 2011, planners must realize that long-term planning is uncertain (if not impossible). Some things, however, are very clear. Estate planning documents drafted prior to the new law should be reviewed; wills and trusts referencing the unified tax credit may have an unintended result, not distributing assets in accordance with the decedent's intent.

Example: A couple with one child has assets totaling $2,500,000. The death of one spouse will result in funding a trust with the maximum amount qualifying for the unified credit; the balance will pass to the surviving spouse. If the first spouse dies in 2002, the survivor would receive $1,500,000. On the other hand, if he dies in 2006, the survivor would receive $500,000.

Insurance. Financial planners should review existing estate planning insurance policies. The need for life insurance should be evaluated, as policies originally purchased to pay estate tax may not be necessary. The type of life insurance should be reviewed, to determine if it is still appropriate, or whether low-cost alternatives are an option. These are all issues a planner should consider.

Conclusion

Just as financial plans incorporate clients' personal goals and objectives, their attitude toward risk and their expectations regarding inflation, client views on the future of the estate tax must be considered. In this regard, it is essential that planners communicate with clients on an ongoing basis.