Saturday, February 26, 2011

Q&A Series - Tax Considerations for Establishing 529 Plans for Grandchildren

Bob, a client with young grandchildren, read our financial aid Q&A and had an additional question regarding establishing 529 plans for his grandchildren.

Q: After reading your post about assets affecting financial aid, I’m thinking about establishing 529 plans for my two wonderful grandchildren. What are the tax considerations?

I’m so glad you asked this question, Bob. Many of our readers have young grandchildren, and I can think of no greater tangible gift than assisting them with their higher education. It creates a direct connection to your grandchildren, even if you are not around when they attend college.

As I stated in my Q&A concerning assets affecting financial aid eligibility,
a relative can establish a 529 plan for a child (in the relative’s name, not the child’s). If it’s set up this way, the assets won’t factor into the child’s financial aid application at all. This is because the contributing relative – not the parents or the child – “owns” the account, with the child named as beneficiary.

If you do establish 529 plans for your grandchildren, for gift tax and generation-skipping transfer tax purposes, your contributions will be treated as gifts to the grandchildren. Accordingly, if you make other gifts to the grandchildren during the same year, you will need to keep your 529 contributions in mind.

Because your contributions would qualify for the $13,000 annual gift tax exclusion, you can make fairly large contributions without incurring the gift tax. Furthermore, you can elect to treat the contribution as made over a five calendar-year period for gift tax purposes if you make a contribution of between $13,000 and $65,000 per beneficiary. This would mean that in Bob’s case, he can contribute up to $130,000 for his two grandchildren combined, which would allow him to utilize as much as $65,000 in annual exclusions to shelter a larger contribution.

Most advantageous about this arrangement is that even though the assets leave your estate, they do not leave your control – a great benefit if you compare it to the typical gift and estate tax laws. There are very few tax laws other than those regarding 529 plans that allow you to gift out of your estate but still maintain control of the assets. Of course, if you later revoke the plan, the account value comes back into your estate and you may owe estate or income taxes. Also, with the five-year averaging election, your estate will have to include a portion of any contributions made if you don't live past the fourth year.

Bob, thanks again for your question. I know that grandparents take great pleasure in being generous to their grandchildren. These substantial gifts would not only be very thoughtful, they would also be of great benefit to your estate from a tax perspective.

We encourage our clients and readers to send us questions for our Q&A series at And as always, we hope you will keep Rollins Financial in mind when seeking professional advice on financial planning and investing.

Best regards,
Joe Rollins

Thursday, February 17, 2011

Q&A Series - Which Assets Affect Financial Aid Eligibility?

This week's question comes from Elizabeth, a reader whose daughter will be starting college in the fall.

Q: We’re starting the financial aid application process, and I’m confused about what assets affect eligibility. What assets are included in the eligibility calculation?

Congratulations, Elizabeth! After years of laughter, tears and arguments, the day your daughter heads off to college is just around the corner. With the amount of college students applying for financial aid, I have a feeling that many of our readers will find this topic interesting, so thank you for your question.

The Basics

Financial aid is structured to help make up the difference between what a family is able to pay and what a college charges. The basic idea is that everyone, regardless of means, should be given the opportunity to go to college.

The majority of financial aid is provided at the federal and state levels, and includes interest-subsidized loans, work-study programs, and grants. Every year, the Federal Student Aid office of the U.S. Department of Education provides more than $150 billion in new aid to approximately 14 million college students. It’s important to note that not all schools participate in the Federal Student Aid programs, so it’s best to check with your school to find out what programs are available.

The first thing to do to access financial aid is apply for it, usually by using the Free Application for Student Aid (FAFSA) form or by completing a specific college’s financial aid form. Both use similar formulas to determine how much need-based aid your child is eligible to receive.

The three basic components of that formula are the cost of attendance (COA); the total resources provided to a child from outside sources (like a scholarship) which reduces the COA on a dollar-for-dollar basis, and; the amount your family is expected to contribute to your child’s college costs based on your particular financial situation, which is called the “Effective Family Contribution” (EFC). Subtract the Resources and EFC from the COA and you arrive at the Financial Need that the aid package will try to cover.

Be sure to pay attention to the deadlines for submitting your student aid application! There are federal and state deadlines, and your college may also have a deadline. The federal deadline for online applications for the 2010-2011 school year is midnight Central Daylight Time, June 30, 2011.

If you’re not sure you’ll qualify, I suggest you apply anyway. The application is necessary for obtaining government-sponsored loans and you may be surprised with how much aid is extended to you.

What Counts, What Doesn’t

According to, the formula to compute EFC uses the following financial resources to pay college expenses:
  • 20% of a student’s assets (money, investments, business interests, and real estate)
  • 50% of a student’s income (after certain allowances)
  • 2.6%-5.6% of a parent’s assets (money, investments, certain business interest, and real estate, based on a sliding income scale and after certain allowances)
  • 22%-47% of a parent’s income (based on a sliding scale and after certain allowances)
For divorced parents, the custodial parent is responsible for completing the FAFSA. It should be noted that any child support and/or alimony received from the non-custodial parent must be included on the FAFSA. The Federal government does not consider the income and assets of the non-custodial parent in determining a student’s financial need.

Fortunately, neither a parent’s nor a child’s qualified retirement assets (investments in 401(k) plans, regular or Roth IRAs) are considered a resource. This makes sense, since those assets are vital to your own and your child’s long-term future. The basic components to determining your EFC are your current income and non-retirement assets. The equity in your primary residence, a family-owned business, insurance policies, and annuities are also excluded from your assets when determining EFC.

How to Increase Aid Potential

Since a child’s own assets and income are reported on financial aid applications at a much higher rate than those of their parents, it’s advantageous to have fewer assets in the child’s name and more in the parents’ names. For that reason, 529 plans tend to be a better choice than custodial accounts. Assets in 529 plans are considered to be the parents’ if the child is a dependent on your tax return. They generally have a fairly low impact on a student’s financial aid eligibility, usually a maximum of 5.6% of the value. On the other hand, custodial accounts are the student’s assets and are assessed at 20% in most cases.

Also worth looking into are 529 plans established in a relative’s name for a child. If a 529 plan is set up this way, it won’t factor into the financial aid application at all. This is because the relative who is contributing – not the parents or the child – owns the account.

Withdrawals from 529 plans expressly used for college expenses are also favorably treated. Because withdrawals of that nature are excluded from your federal income tax return, they are not required to be included as income on the FAFSA.

On the other hand, withdrawals from retirement accounts for college expenses aren’t treated as advantageously. While you can take money out of your Roth or traditional IRA for qualified college expenses penalty-free, it may put your financial aid eligibility at risk the following year. The entire withdrawal plus principal and earnings count as income on the following year’s application.

As briefly touched on above, it’s also unwise to withdraw IRA assets to pay for your child’s college expenses because it infringes upon your own retirement preparation. I cannot stress enough that you should never pay for your child’s postsecondary education instead of saving for your own retirement during your working years.

Additional Resources on Financial Aid

FAFSA official website
Federal Student Aid on the Web
FinAid! The Smart Student Guide to Financial Aid

Elizabeth, thanks again for your question. I hope my explanation has given you some understanding of the financial aid process and the components that might affect your daughter’s eligibility. Good luck to both of you in this exciting new chapter of your lives!

We encourage our clients and readers to send us questions for our Q&A series at And as always, we hope you will keep Rollins Financial in mind when seeking professional advice on financial planning and investing.

Best regards,
Joe Rollins

Tuesday, February 15, 2011

U.S. Runs $50 Billion Budget Deficit in January

From the Desk of Joe Rollins

A few years ago, I assisted a client who had been denied by the U.S. Department of Housing and Urban Development (HUD) in his application for an FHA (Federal Housing Administration) loan. My client and I traveled to Washington, D.C. to visit with HUD officials and politicians from my client’s voting district. It wound up being quite an eye-opening day trip.

After landing at Washington Dulles International Airport, we took a cab to the HUD office, which took a while due to D.C.’s gridlocked traffic (if you think Atlanta’s traffic is bad, I suggest trying to drive through D.C.) The HUD building in Washington, D.C. is quite impressive; it’s a typical stately building that takes up an entire city block and that is approximately 10 floors. After going through security at the HUD office, we were escorted to the 5th floor.

As we walked down the corridor to meet with the HUD representative, I couldn’t help but be completely amazed by the number of employees on that floor alone. Peeking into the relatively standard sized offices, I noticed that each was jam-packed with five or six desks. It made me wonder what sort of projects required this many employees.

During a meeting break, my client and I grabbed lunch in the cafeteria along with about 1,000 HUD employees who were hurriedly eating their meals to get back to their HUD tasks. As the meeting continued, I became even more amazed with the endless bureaucracy of scheduled appointments and other activities carried on by the HUD officials. Eventually, my client received the FHA loan, but it was not without continuous meetings, correspondence and political influence that lasted well over a year.

The subject of this post made me reminisce about my HUD experience and wonder why all of those employees are necessary. Last week, Rand Paul wrote an opinion piece for the Wall Street Journal, “A Modest $500 Billion Proposal.” As you likely know, Rand Paul is the junior Republican senator from Kentucky and is also a member of the Tea Party movement. I honestly hadn’t paid much attention to Rand Paul before the WSJ article, but I was intrigued by Paul’s proposal to immediately cut $500 billion in spending. Initially, I dismissed his proposal as totally unfeasible. However, after doing some research, I’m not so sure his plan isn’t doable.

Rand Paul is the son of American physician and Texas Congressman Ron Paul. Ron Paul has been in Congress on and off since the mid 1970’s and ran in the 1988 and 2008 presidential elections. There is speculation that he is planning to run in the 2012 presidential election. I find many of Ron Paul’s political positions to be somewhat nutty – he is a hardline Constitutionalist and libertarian who insists that he will “never vote for legislation unless the proposed measure is expressly authorized by the Constitution,” which gave him the nickname “Dr. No.”

As a libertarian, Ron Paul advocates a much smaller government. That’s something I believe in, too, but not in such an extreme fashion. He does not believe in military operations outside the U.S. borders and would like to immediately withdraw all troops from all foreign countries. Ron Paul opposes the collection of individual income taxes, and believes that things like excise taxes should be implemented instead. He also supports the gradual elimination of the Federal Reserve System in an effort to let market forces control interest rates. This, in particular, gives him a lack of credibility in almost every respect.

Basically, Ron Paul believes that almost everything should be decided at the state level, and that the states should regulate all social matters not directly specified in the Constitution. While some of his causes may be admirable, many of his positions are extreme and polarizing.

Rand Paul’s educational background is similar to his father’s. He is a practicing ophthalmologist with his own clinic in Bowling Green, Kentucky, having received his medical degree from Duke University. While he shares many of Dr. No’s political positions, he doesn’t seem quite as radical. With Rand Paul’s affiliation with the Tea Party movement and his political activism, the current administration would be ill-advised to disregard him.

I am impressed by Paul Ryan, the U.S. Representative from Wisconsin who is the chairman of the House Budget Committee. Ryan has appeared on CNBC and other news networks discussing economic issues. I find him to be one of the few members of Congress with an intellectual understanding of the Federal budget and how it works.

Recently, Paul Ryan issued the House GOP budget proposal for the rest of the 2011 fiscal year. In it, a Federal spending reduction of a prorated $38 billion was proposed of the $100 billion decrease the Republicans promised during the campaigns. The theory is that with only seven months left in the fiscal year once the budget is approved on March 4, 2011, $38 billion would be the prorated savings of the $100 billion commitment.

As you are probably aware, there is currently no Federal budget. The Obama Administration has not passed a revised budget for fiscal 2011 even though the Democrats had control over the House, the Senate and the Executive Branch. Even they cannot agree to any type of spending levels.

It is estimated that the Federal deficit for fiscal 2011 will be close to $1.65 trillion, which is somewhat larger than last year’s deficit and will be the largest ever in the U.S. As anyone with a household budget knows, deficits can’t go on continuously, and $38 billion towards this level of deficit is only a drop in that proverbial bucket.

Let’s put this in perspective – a $38 billion reduction in the deficit would bring it to $1.6462 trillion. The GOP has amended their spending cuts to be a true $100 billion in savings. Big whoop! Again, this is a very small reduction in Federal spending for an absolutely ridiculous deficit.

Even though the entire country is now focused on deficit reduction, the Obama Administration does not appear to have gotten the drift. It’s reported that this week, the Executive Branch will propose a new high-speed rail program being spurred by $8 billion in Recovery Act grants plus additional deficits totaling approximately $50 billion. While this program may be needed, it should not be financed by the Federal government without extraordinary deficit cuts elsewhere in the budget.

The White House announced the President’s budget for fiscal year 2012 on Monday morning. It is projected that over the next 10 years, the Federal deficit will be cut by $1 trillion. Notwithstanding the fact that the President’s appointed Deficit Compromise Committee had recommended a reduction of deficits of $4 trillion, the President only recommended a deficit reduction of $1 trillion. It was not pointed out that over the next 10 year period, over $10 trillion in new debt will be added to the U.S. economy. Remember -- $10 trillion is greater than all the debts ever created in the United States before 2008. Quite frankly, if we wait 10 years to get the Federal deficit anywhere close to being balanced, we will be giving away the U.S.’s credibility and financial stability.

All of these things get me back to Rand Paul’s proposal in the WSJ, which I actually think has some merit. He is proposing major cuts to the Departments of Agriculture and Transportation, which he says would save about $84 billion. He is also proposing cuts to the Departments of Energy and Housing and Urban Development to the tune of $50 billion each, and would also like to cut $80 billion by “removing education from the federal government’s jurisdiction,” meaning that the states would operate their own education departments.

I have always believed that education is a state priority that should be handled at the local level. In all honesty, I do not understand how the U.S. Department of Education can spend $100 billion with what they do, and it’s absurd to me that college loan programs are run out of Washington when it should be a local bank function.

In addition, Rand Paul proposed reductions in international aid and other agencies, for a grand total of over $500 billion in spending cuts. Nothing in his proposal would affect Social Security or Medicare.

President Obama has already proposed major cuts to the Department of Defense, a move that everyone should agree with since this department has grown 120% in costs in the last decade. These costs are in addition to those from the Iraq and Afghanistan wars. Almost everyone realizes that this department has grown too big, become too bureaucratic and become too inefficient.

Rand Paul’s spending cut proposal along with some reasonable changes to Social Security and Medicare could reduce the Federal deficit by almost 50% in one year. There will almost assuredly need to be an increase the Social Security retirement age, an increase in taxes and some form of a user fee for Medicare recipients. A big dent could be put in the Federal deficit over a short period of time if the politicians in Washington had the political willpower to implement these spending cuts.

Many will undoubtedly question how these cutbacks will displace perhaps a million or so Federal workers. I reiterate that I don’t think it’s fair for U.S. taxpayers to continue to subsidize Federal employees that may not be providing valuable services. If these employees are so talented and necessary, then the private sector will assuredly rush to hire them. It’s inconceivable that these employees would not find gainful employment outside of the public sector.

The Obama Administration argues that such large cuts in Federal funding would be detrimental to our current economy and to employment. However, it’s easily argued that after trillions of dollars in Federal stimulus and low interest rates, employment levels have barely budged. It would seem logical to assert that if that plan has not worked and the long-term stability of the financial systems in the U.S. has been compromised, then perhaps another tactic is worthy of a try.

Frankly, I would rather have a bad economy and no deficits than a bad economy and gigantic deficits.

As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Best regards,
Joe Rollins

Wednesday, February 2, 2011


From the Desk of Joe Rollins

On Friday, January 28th, the Commerce Department reported a 3.2% GDP growth in the U.S. economy for the 4th quarter of 2010, which barely raised an eyebrow on Wall Street since the focus was on the unrest in Egypt. At the time, there were a few thousand protesters in the streets of Egypt, giving the momentum traders on Wall Street incentive to sell off the market in spite of the good GDP report.

Many commentators argued that the forecast for the GDP wound up being 0.3% lower than the originally forecasted 3.5%, and that this was a negative sign for the economy. Anytime I hear that explanation for why the stock market went down, I wonder if the real issue is that the commentators don’t have a grip on the actual news.

This past weekend was beautiful in Atlanta with the temperatures approaching 70 degrees, and I was lucky enough to actually get out and hit some golf balls. I rather doubt that any of my Atlanta readers read the Commerce Department’s GDP report this weekend instead of enjoying the excellent and unseasonable weather. In any event, reams of positive information from this report went totally ignored by the financial commentators. One of my goals for my blog posts is to provide my readers with information that is not readily available in the financial press.

As you likely know, GDP is the gross domestic product of any particular country. While the U.S. has the largest GDP of any country, it has suffered a major decline over the past few years. With the Commerce Department’s 4th quarter GDP report, the annual GDP of the United States borders on $13.86 trillion. This is equal to the 2007 GDP before the recession started. On a per capita basis, GDP has yet to reach pre-recession levels, but the fact that we have gotten back to even is quite an accomplishment.

I continually read that China’s GDP will soon overtake the United States. While it’s true that China’s GDP is reported to be growing at approximately 10% annualized, their economy is only at $5.3 trillion in 2010 as compared to the U.S.’s almost $14 trillion economy. It will be a few more years before China’s economy even approaches the U.S.’s mammoth economy. Additionally, China’s economy simply cannot grow at those levels without a setback in a few years.

I can't help but be impressed by the components of the GDP report. One observation that seems to be overlooked is the definition of a recession. Most economic textbooks define a recession as two consecutive declines in quarterly GDP. While there’s no question that the U.S. suffered a recession in late 2008 through the beginning of 2009, the real question is why didn’t we have a more robust recovery after it was over?

Beginning in the middle of 2008, the U.S. suffered four negative GDP quarters. Beginning with the GDP for the 3rd quarter of 2009, GDP started turning up. The Commerce Department has now recorded six positive GDP quarters since that time.

Volumes of articles have been written regarding the possibility of a double-dip recession in the United States with many respected economists forecasting that a double-dip recession was almost inevitable given the U.S. economy’s weak recovery. You may recall that I dismissed such a possibility a year ago in my February 6, 2010 post, Ding-Dong! The Recession is Dead, and I reiterate now that there was never a possibility that the U.S. economy would slip back into a recession. Given the strength of the numbers illustrated below, the U.S. economy in the 4th quarter of 2010 was refreshingly robust.

Buried in the Commerce Department’s numbers were some outstanding increases. Final sales is a good indicator for demand in the economy, and it had its largest increase since 1984, growing 7.1%. Just think about that growth percentage – it took almost 30 years for the economy to snap back to such a large percentage in final sales.

When final sales are so large, it’s natural to wonder why GDP would be reported at such an anemic level of 3.2%. How GDP is calculated is partly the answer. One of the GDP calculation components is the effect of inventories. During this quarter, it would be natural to conclude that inventories would be diminished. Given the Christmas season and the seasonal sales that occur during that time, inventories would naturally be lower at the end of December than they were at the beginning of October going into the increase in inventory for the Christmas retail season.

During the 4th quarter of 2010, private inventories were at -3.7%, creating an enormous drag on the calculation of GDP. This percentage decrease was unusual given that it followed five quarters when inventories were increasing. This illustrates the strength of the Christmas season that inventories took a major decline.

You would have to be living under a rock to not realize that businesses will increase and inventories will replenish to pre-4th quarter levels. As the significant increase in inventories occurs, due to the calculation of mathematical economic ratios, we should see GDP shrink. It’s almost guaranteed that with the turnaround in inventories, the GDP growth in the coming quarters will be robust. Interestingly, the decline in inventories was greater than the decline during the heart of the recession. The fact that inventories had gone up for five consecutive quarters underscores the significance of this decline.

The GDP report had more positive news for the economy. The values of exports went up 1% and have been up now six straight quarters. This is important because it indicates that U.S. manufacturing is growing and the U.S. has become more competitive in worldwide markets. Also significant is the fact that imports during the 4th quarter declined. Exports increased while imports decreased, which are moves in the right direction since they reflect that U.S. manufacturing is up while our reliance on imports has decreased. Almost assuredly, as U.S. companies increase the levels of their inventory, both of these components of U.S. manufacturing shall be positive.

It’s also important to realize that 70% of the calculation of GDP has to do with personal consumption. Personal consumption in the 4th quarter of 2010 was at 3% -- the highest it has been in years. Therefore, almost every component of the GDP calculation was extraordinarily strong except for the liquidation of inventories, which almost assuredly will move upward in the coming quarters.

It appears that based on the empirical evidence offered by the Commerce Department’s GDP report, we should expect significantly higher GDP growth in the 1st and 2nd quarters of 2011. GDP in the 4% range would be above trend if it occurs.

In my January 25, 2011 post, Dow 12,000 - Who'd a Thunk It, I commented on the strength of earnings for U.S. corporations. It was interesting to read the analogy on the same subject in Monday morning’s Wall Street Journal, U.S. Corporate Markets Surge, which illustrates extraordinary growth and earnings for the S&P 500 companies. As you can see, I don’t make up the information in my posts – they are based on facts.

If corporate earnings are up like gangbusters and we expect higher GDP growth in the coming quarters, what investment analogy can be drawn? First, you have to assume that higher stock prices are based upon higher earnings, an analogy I have illustrated often. With higher earnings and higher GDP, we should expect higher stock prices.

With a better economy, we will almost assuredly not enjoy the support of the economy that the Federal Reserve has been offering. Quite frankly, the Fed is way overdue in increasing interest rates. As I’m sure you’re painfully aware, bond prices move inversely to interest rates. It’s certainly likely that bond prices will be negatively impacted by higher interest rates in the coming months.

In summary, stocks will be higher, bonds will be lower, and your financial future will be more stable if you make additional investments for your future.

As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Best regards,
Joe Rollins