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What to Do with a $10,000 Inheritance for the Benefit of Four Relatives of the Deceased

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There are many personal and financial issues to consider when deciding what to do with an inheritance. For this discussion, assume you are responsible for determining what to do with $10,000 that was designated for a deceased relative's four minor children, ranging in age from one to 12, in the amount of $2,500 each.

Assuming that there are no special needs that need to be taken care of immediately for these four minors, an education savings plan might be a wise choice. A Coverdell Education savings account or 529 college savings plan can be used to build an education "legacy" for the four children. These two savings plans are nifty devices that can help make sure there are funds available for education when the time comes. Many financial advisers use these tax-advantaged plans as a tool to meet education-related goals.

The Coverdell Education savings account allows earnings inside of it to grow free from tax, and withdrawals for qualified elementary, secondary, and higher education expenses are free from federal tax. The beneficiary may assume control at the age of majority, which is 18 or 21 in most states. The contribution limits are $2,000 per year per beneficiary. The advantage to this education savings account plan is that the qualified distributions free of federal taxes can be applied to elementary, secondary, and higher education expenses (i.e., not just to higher education expenses). If you did not want to make each child's contributions over a two-year period, due to the $2,000 annual contribution limit, you could then take the remaining $500 portion of the inheritance left after opening a Coverdell Education savings account for $2,000 and open an UTMA account for each minor. You could use the UTMA account to educate each of the children about the importance of developing a solid savings habit early. The UTMA account could be used by each child to save other future monetary gifts they might receive or earnings from part-time jobs they may later have. A minor assumes control over an UTMA account at the age of majority. Hopefully, by this time you will have emphasized the importance of developing a solid savings habit early in life, and they will be able to manage the funds properly when they assume control. Although there is no tax deferral on the earnings in an UTMA account each year, hopefully the tax, if any, will not be significant.



The 529 college savings plan allows earnings inside of it to grow free from tax, and withdrawals for qualified higher education expenses are free from federal tax. Assuming you are the owner of the 529 college savings plans, you would maintain control of the assets, decide when withdrawals can be made, and be able to change the beneficiary of the plan. There are high contribution limits per beneficiary, so the $2,500 inheritance amount per child would not be an issue in your specific case. The 529 plan can actually potentially become a multi-generation program. Should the originally designated minor not actually use the funds for college, the beneficiary can later be changed to that child's child and so on.

The use of 529 college savings plans can be researched further at Savingforcollege.com. This is a popular website that lists many of the features of various 529 college savings plans currently available. The stock market can be a good place to accumulate wealth over a long period of time, but can be very volatile in the short term. In an ideal situation, saving for college begins early in a child's life so that the money can grow over time, preferably using a diversified portfolio. You will want to either consult with a CPA or financial adviser to develop a proper diversified portfolio or use a plan that has an age-based approach feature option that allows for automatic rebalancing in the investment portfolio. This age-based approach will automatically shift the portfolio's percentage of stocks and bonds over time, using standard age-based models to adjust risk.

The 529 college savings plan and Coverdell Education savings account are two tax-advantaged plans that are powerful tools to consider when developing an educational legacy. As with many financial goals, consider taking the time to consult with your personal CPA/financial planner to develop a program to meet your specific needs and goals. Yes, you can develop an education legacy or financial legacy for your relatives by doing a little planning.

About the Author

Dwight Nakata, CPA, CFP®, is a member of the Orange County chapter of the Financial Planning Association and the Orange County/Long Beach chapter of the California Society of Certified Public Accountants. He has an independent financial planning firm and is also currently a partner in a CPA firm in Southern California. Contact him at 714-329-5022 or dwight.nakata@genworthrr.com or cpa.nakata@earthlink.net.

IRS Circular 230 Disclosure, pursuant to Internal Revenue Service Circular 230: Any tax advice contained in this communication does not constitute a formal opinion satisfying such requirements under IRS Circular 230. The tax advice included in this written or electronic communication was not intended or written to be used, and it cannot be used by the user/recipient of this document, for the purpose of avoiding any penalties that may be imposed by any governmental taxing authority or agency.


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