Since October 4, 1999, the California Golden State ScholarShare program has allowed a contributor (donor) to set aside funds in an account that grows free of federal and state income taxes to fund the expenses of higher education. Higher education includes undergraduate studies, graduate studies, professional studies and studies at certain approved vocational and technical schools.
ScholarShare was adopted under Section 529 of the Internal Revenue Code and permits substantial flexibility as to who can be the contributor and who can benefit from the account. Under the program, parents can save for children, grandparents can save for grandchildren, friends can save for friend's children and relatives can save for the children of other relatives. You can also save for your own education.
Accounts can be set up for a single beneficiary by multiple contributors (such as both sets of grandparents). In fact, anyone can save for themselves or for anyone else so long as the funds are earmarked for education and so long as the total contributions for a particular beneficiary do no exceed the maximum contribution limit. These limits are described below.
Unlike many other "education plans" that limit the use of the funds to "in state" institutions or to tuition expenses only ScholarShare proceeds can be used at any accredited institution in the United States and can be used to pay tuition, certain room and board expenses, books, fees and supplies. The college need not be specified at the outset, but he maximum amount that can be contributed to the fund will be determined by the type of college (public or private) selected and the age of the beneficiary. The maximum contribution limit is based upon the beneficiary's age and the estimated costs for the highest cost institution for the year the beneficiary would normally enroll. Thus a larger contribution can be made by funding the program to a higher-cost private institution, even though the beneficiary may never attend that college (for example, tuition, fees, room and board at Stanford University currently are approximately $33,600 per year) or for an older beneficiary. Funds are disbursed from the program directly to the institution at which the student enrolls.
There is no California residency requirement for either the contributor or the beneficiary. There is no cost to set up the plan, but the annual administration fees run approximately eight-tenths of one percent (.8%) of the account value per year.
ScholarShare funds will be invested by Teachers Insurance and Annuity Association - College Retirement Equities Fund (TIAA-CREF), the world's largest pension fund. Four investment options, or any combination of these options, are available to the contributor:
Age Based Asset Allocation Option - Age-based investment portfolios that combine stock, bond, and money market mutual funds. While TIAA-CREF will make the investment decisions, the asset allocation of the particular account will be determined based upon the age of the student and the time until enrollment in college is expected. The younger the beneficiary, the heavier the weighting in stocks; the older the beneficiary, the greater the allocation to bonds and cash.
100% Equity Option - Domestic and International stocks, with approximately 80% being invested in the TIAA-CREF Institutional Growth Fund and 20% being invested in the TIAA-CREF Institutional International Equity Fund.
100% Social Choice Equity Option - Equities chosen with special consideration to certain social criteria utilizing the TIAA-CREF Institutional Social Choice Equity Fund.
Guaranteed Option - A guaranteed funding agreement that guarantees the ScholarShare Trust both a return of principal and a fixed rate of return.
Once funds have been invested in a particular option, those funds cannot be transferred to any of the other investment options; however, future contributions may be directed to any of the four programs.
A favorable feature of the plan is that, unlike a gift under the Uniform Transfer to Minors Act (UTMA) or a trust in which the beneficiary designation is irrevocable, the contributor controls how the ScholarShare account is distributed and can change the account beneficiary to any other family member of the designated beneficiary. This includes siblings, parents, children, in-laws, aunts, uncles, nieces and nephews of the designated beneficiary. The contributor also can terminate and retrieve the account, in which case the contributor will pay income taxes and a 10% penalty on the income portion of the money received. However, if the beneficiary dies or becomes disabled the account may be terminated without penalty. If the beneficiary receives a scholarship, the contributor can withdraw up to the amount of the scholarship without penalty. Of course, income taxes will still be payable on the income portion of the money received.
If the beneficiary does not attend college, and no alternate beneficiary is designated by the contributor, the funds can be left in the account for the benefit of the beneficiary in case he or she returns to school. However, the account must be closed no later that 10 years from the date the beneficiary turns 35, or 10 years from the date the account is established if the beneficiary is 35 or older at that date.
It should be noted that while the contributions to the plan are not tax-deductible, the earnings of the account accumulate tax-deferred until distribution. At the time of distribution, the income portion of each distribution is taxed as ordinary income at the beneficiary's' rate as if the distribution were an annuity payment (i.e., part income and part return of principal). This generally should prove to be beneficial because it is likely that the beneficiary's tax bracket will be lower than that of the contributor. The downside is that capital gain earned by the account is converted to ordinary income, as compared to capital gain earned in a UTMA account or a trust, where gain would be taxed as capital gain, albeit on a current basis.
From an estate-planning viewpoint, contributions to a ScholarShare account are considered gifts. As such, the contributions, and the earnings of the account, are removed from the contributor's estate (except to the extent reclaimed by the contributor by withdrawal or termination of the account) even though the contributor retains an element of control to change the beneficiaries or revoke the transfer. The gift qualifies for the $10,000 annual gift tax exclusion and a special rule allows a contribution to be prorated over the current year and the succeeding four years, thus permitting up to $50,000 to be contributed in one year without gift tax consequences so long as additional gifts are not made to the beneficiary in any of the four following years.
ScholarShare may not be the program of choice for all taxpayers desiring to establish an education fund. It is not clear what would happen if the contributor dies and the beneficiary thereafter elects not to attend college. For example, who would determine where the funds goes and to whom and how would the account be taxed? Also, the conversion of capital gains to ordinary income may have an overall negative effect on the ultimate "spendable" amount. Further, since the payments are made directly to the college, but are taxed to the student, where does the "tax money' come from? Another open issue is whether the account will be treated as an asset of the beneficiary or an asset of the beneficiary's parents for financial aid purposes, and how the financial aid rules will be applied if the student seeks financial aid. Lastly, a combination of plans (i.e., ScholarShare, UTMA gifts and gifts to irrevocable trusts) may prove more advantageous than the use of ScholarShare alone.
For more information on ScholarShare generally, click on, www.scholarshare.com. For how ScholarShare may benefit you in your estate planning, please contact Melvin S. Spears, Marvin H. Lewis, or Reeve Chudd at Ervin, Cohen & Jessup LLP.
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