This week, Gail answers a question on annuity eligibility and explains how to invest in a 529 plan that's not sponsored by your home state.

 

Dear Ms. Buckner,

A family member was told that people who have had cancer are "excluded" from purchasing annuities. If so, is that because their life expectancy is considered compromised?

Thank you.

Ann

 

Dear Ann-

As you're probably aware, an annuity combines an investment that has either a fixed or variable return with a life insurance policy. When the owner of the annuity dies, his/her heirs are paid an amount at least equal to what was invested in the account (minus any withdrawals of principal).

I'm surprised to hear someone you know is being refused an annuity on health grounds. While an insurance company reserves the right to turn down any type of business it wants, the risk an insurance company takes on for an annuity is quite different from the risk assumed for regular life insurance. In fact, the risk to the insurance company is that the annuitant will live longer than expected. A person with a compromised life expectancy is a good risk for the insurance company issuing the annuity.

For that reason, most annuity applications do not specifically ask if the applicant had or has cancer or a life-threatening illness. Just because your relative ran into one policy that did doesn't mean she should give up.

My advice is to shop around. If she isn't currently working with a financial advisor, she should consider contacting someone who can help her find a company willing to accept an annuity holder with the profile you outline. It should not be difficult to find one. Answer the application questions honestly, but don't feel obligated to divulge more information than specifically requested.

Best wishes -

Gail

 

 

We recently opened a 529 college savings plan in Iowa for each of our two sons. We are Missouri residents. Can we deduct our contributions to the Iowa 529 from on our Missouri state tax return? Or could we only do that if we were investing in a Missouri 529 plan? I'm aware that each state has maximums they allow for deductions, but I'm not sure if we can do that across states. Would we be better off moving the 529 to Missouri? Would the earnings be taxable in either plan?

Thanks for any advice you have.

Judy

 

Dear Judy-

Here's a little secret: states make money off 529 plans. But only on the plans they sponsor. So they create all kinds of roadblocks and incentives to steer you to your home-state plan.

Don't get me wrong: states are hardly getting rich off these plans. Mostly, the fees they collect are being used to cover such things as administrative costs, advertising, and scholarships for especially needy students.

I just want you to understand the motivation behind the tax breaks which, incidentally, a state can legally only extend to its own citizens. Iowa, for instance, has no authority to grant residents of other states a tax deduction for contributing to the Iowa 529 plan. It can only do this for Iowa residents.

I'm not sure why as Missouri residents you opened 529 accounts in Iowa, but the state of Missouri does not recognize contributions to other states' plans. However, if you had used the Missouri plan, together, you and your husband could have deducted up to $16,000 for each account. (Missouri has a maximum deductible contribution of $8,000 per donor per year.)

It's unfortunate that states do not take a more broad-minded approach to these plans. You'd think they'd recognize that an educated population is in their best interest -- literally. Educated workers command higher incomes and attract high quality employers, both of which generate significant taxes which are paid to the state!

In addition to not granting residents a tax deduction if they contribute to another state's 529 plan, many states take the "my-way-or-the-highway" approach and impose income tax on your withdrawals unless you use "their" plan. The good news is that both Missouri and Iowa have decided to follow the federal government's lead and waive income taxes on withdrawals from ANY 529 plan, even those from an out-of-state plan.

529 plans are state-sponsored securities and every state is free to impose its own tax breaks and restrictions. That's what makes it confusing and difficult to evaluate plans. There are no "apples-to-apples" comparisons.

In any event, an up-front tax deduction should not be the deciding factor when you're choosing a 529 plan for a child you care about. In your case, since the state income tax rate in Missouri is 6%, if you and your husband contributed $16,000 to a child's 529 account and qualified for the maximum tax deduction, you would shave $960 off your state income tax ($16,000 x 6%).

You might think, "Great! We saved almost a thousand bucks in taxes." And you'd be wrong.

That's because any tax you pay to your state can be subtracted from your income when you're calculating your federal tax bill, assuming you itemize deductions. Since you did not pay $960 to Missouri thanks to the 529 deduction, the income you report on your federal return is $960 higher. If you're in the 30% bracket, this means you'll have to pay $288 more in federal taxes ($960 x 30%).

So your "net" tax savings is $672, not $960 ($960 minus $288). Nothing to sneeze at, but not as good as you first thought.

If you want to contribute more than $8,000 apiece to a child's Missouri account, you do not get any additional tax breaks. While some states, such as Ohio, let you "carry forward" 529 contributions and use them to offset your income in later years, Missouri does not. One strategy you may want to consider is contributing to your in-state plan up to the amount you're able to deduct. Then go with another state's plan for the balance of your contribution if it offers different options or the potential for better investment returns.

Frankly, people overemphasize the up-front tax deduction some plans offer and lose sight of the big picture: that is, how well your money is being managed. For instance, let's assume you make an $8,000 contribution, don't add another penny and keep the money in the account for 18 years. An investment return of just one percent more per year would more than offset any tax savings you received when you contributed to the plan. The longer you can let the money compound in the account, the greater the difference 1% annually will make.

Consider keeping track of how your investments do in the Iowa plan versus what they might have earned in the Missouri plan. If Missouri's investments have better performance, you can transfer the accounts to the Missouri plan (sorry, no tax deduction on transferred amounts) without any tax consequences, provided the account is at least 12 months old.

In addition to investment performance issues, there are estate planning considerations that affect 529 plans. Making a mistake can be costly. In fact, it could wipe out the entire tax deduction you received. In light of the fact you're already questioning what you did, you might consider discussing your situation with a financial advisor who can guide you through these decisions and regulations.

But remember: no matter which state's plan you choose, as long as withdrawals are used for college-related expenses, the gains will always be free of federal tax. And the savings at that level is a lot more significant because federal tax rates are much higher than what the states impose.

Don't beat yourself up over this. As I've said here before, in my opinion, 529's are the smartest way to save for college. Making a commitment and opening an account is a huge accomplishment in and of itself. A good place to go for an overview of 529 plans is www.savingforcollege.com. There are links to every state's plan so you can check them out before you decide.

Your sons are lucky their Mom & Dad have taken this important step on their behalf.

Best wishes,

Gail

 

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The views expressed in this article are those of Ms. Buckner or the individual commentator, and do not necessarily reflect the views of Putnam Investments Inc. or any of its affiliates. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.