Q: I am thinking of opening custodian accounts for my children's college education. However, I am concerned that the savings my children have in their own names could affect their ability to obtain financial aid or loans for college. Can you please explain how these accounts are viewed by colleges when evaluating financial aid applications? --S.L.
A: Let me understand this: You want to set up a fund to help pay for your child's college education, but you don't want this fund to interfere with his or her ability to get financial assistance from taxpayers or college donors? Well, you can't have it both ways.
According to officials in the financial aid office at UCLA, colleges and universities disbursing taxpayer student aid funds are all required to apply the same "need analysis" formula.
If the student is still a dependent of his or her parents, this formula takes into account the assets and income of the parents and the student and is applied regardless of whether the student is applying for grants, loans, scholarships or work-study positions on campus.
This means that universities and colleges are required to look at the income and net worth of both the student and the parents in doling out financial aid. This year, the formula requires that 35% of the student's savings be counted toward his ability to pay his costs of attending college.
"Financial aid is a need-based program, and students must qualify on the basis of their income and assets as well as their parents' income and assets," explained an official of the UCLA student aid office. However, private universities disbursing private funds may follow other guidelines as dictated by the terms of some endowments and other scholarship criteria.
What can we learn from this? If establishing college savings for your children places a difficult burden on you now, you are probably better off skipping the savings plan and using the money to take care of your family's immediate needs. Then, when your child is ready to enter college, and assuming that the same financial aid rules apply, he will qualify for a larger amount of assistance.
However, if you have the money to open a college savings account, you should. You are probably better off saving for college now than spending the money that you will need when your children enter college and your net worth statement shows that you ought to have the wherewithal to cover the bills.
Two Issues Involved if IRA Loses Value
Q: During the past several months, two of your columns dealt with what appears to me to be the same issue: losses in an individual retirement account. In one instance, you said taxpayers are not entitled to write off their losses in an IRA. But just a few weeks ago, you said the trustee of an IRA should have valued the account at its current fair market value, not its original value--a valuation that essentially allowed the taxpayer to recognize a loss. Can you please clarify this matter? --W.L.J.
A: There are two separate issues here: recognizing that an IRA has lost value and a taxpayer's ability to deduct that loss from his taxes. A taxpayer is entitled to do the former but not the latter.
Here's how it works: Let's say you open an IRA for $10,000 and it declines in value over the years to $1,000. Now, let's say you decide to withdraw your funds and close the account. When you withdraw $1,000, you should be taxed on that disbursement--not the full $10,000 with which you opened the account.
However, you are not entitled at this point to write off the missing $9,000 on your taxes as an investment loss because the government does not permit a tax deduction for losses of still-untaxed funds.
Can you see the difference? You are not penalized for losing money in your IRA, but those losses are not entitled to a tax deduction.
Living Trust Doesn't End Need for Planning
Q: I read with alarm your recent column concerning what to do with a living trust when a spouse dies. We have a living trust and were under the impression that this would eliminate all problems. What "costly and unnecessary" complications were you referring to when you said living trusts should be reviewed by an attorney after the death of one spouse? --M.R.H.
A: Despite what you may have been led to believe by attorneys and others pushing living trusts as the ultimate estate planning panacea, the benefits of these arrangements are often overstated and oversold.
No matter what you may have been told, establishing a living trust and assigning your assets to it does not automatically complete your estate planning obligations.
This is especially true on the death of the first spouse. Often a living trust calls for establishing special types of tax-saving trusts upon the death of the first spouse, and these trusts must be funded immediately. Failure to do so could expose the surviving spouse and his or her heirs to unnecessary and costly tax consequences.
You would be wise to review your living trust carefully to determine what it calls for when the first spouse dies.
Read the fine print, and, if you don't understand it, consult your attorney for a full explanation of your obligations. You should have a clear understanding now of how your assets are to be handled rather than wait until your spouse dies.
The weeks and months after a spouse's death are no time to be trying to understand the fine points of estate planning.