What is a “Stock”?
A type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings.
- There are two main types of stock: common and preferred.
-
Common stock usually entitles the owner to vote at shareholders' meetings and to receive dividends.
-
Preferred stock generally does not have voting rights, but has a higher claim on assets and earnings than the common shares.
For example, owners of preferred stock receive dividends before common shareholders and have priority in the event that a company goes bankrupt and is liquidated.
What is an “Option”?
A financial derivative that represents a contract sold by one party (option writer) to another party (option holder).
The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date).
-
Call options give the option to buy at certain price, so the buyer would want the stock to go up.
-
Put options give the option to sell at a certain price, so the buyer would want the stock to go down.
Options are extremely versatile securities that can be used in many different ways. Traders use options to speculate, which is a relatively risky practice, while hedgers use options to reduce the risk of holding an asset.
What is a “Bond”?
A debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate.
Bonds are used by companies, municipalities, states and U.S. and foreign governments to finance a variety of projects and activities.
Bonds
are commonly referred to as fixed-income securities and are one of the
three main asset classes, along with stocks and cash equivalents
The
indebted entity (issuer) issues a bond that states the interest rate
(coupon) that will be paid and when the loaned funds (bond principal)
are to be returned (maturity date). Interest on bonds is usually paid
every six months (semi-annually). The main categories of bonds are
corporate bonds, municipal bonds, and U.S. Treasury bonds, notes and
bills, which are collectively referred to as simply "Treasuries".
Two
features of a bond - credit quality and duration - are the principal
determinants of a bond's interest rate. Bond maturities range from a
90-day Treasury bill to a 30-year government bond. Corporate and
municipals are typically in the three to 10-year range.
Read more: http://www.investopedia.com/terms/b/bond.asp#ixzz1uxmb6FQi
What is an “ETF”?
A security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange.
ETFs experience price changes throughout the day as they are bought and sold.
Because it trades like a stock, an ETF does not have its net asset value (NAV) calculated every day like a mutual fund does.
By owning an ETF, you get the diversification of an index fund as well as the ability to sell short, buy on margin and purchase as little as one share. Another advantage is that the expense ratios for most ETFs are lower than those of the average mutual fund. When buying and selling ETFs, you have to pay the same commission to your broker that you'd pay on any regular order.One of the most widely known ETFs is called the Spider (SPDR), which tracks the S&P 500 index and trades under the symbol SPY.
Read more: http://www.investopedia.com/terms/e/etf.asp#ixzz1uxn625Y8
An
investment vehicle that is made up of a pool of funds collected from
many investors for the purpose of investing in securities such as
stocks, bonds, money market instruments and similar assets. Mutual funds
are operated by money managers, who invest the fund's capital and
attempt to produce capital gains and income for the fund's investors. A
mutual fund's portfolio is structured and maintained to match the
investment objectives stated in its prospectus.
One of the main
advantages of mutual funds is that they give small investors access
to professionally managed, diversified portfolios of equities, bonds and
other securities, which would be quite difficult (if not impossible) to
create with a small amount of capital. Each shareholder participates
proportionally in the gain or loss of the fund. Mutual fund units, or
shares, are issued and can typically be purchased or redeemed as needed
at the fund's current net asset value (NAV) per share, which is
sometimes expressed as NAVPS.
Exchange Traded Notes - An Alternative To ETFs
SEE: Commodities: The Portfolio Hedge.
In this article, we'll explain this innovative approach to index investing and compare it to its cousin, the ETF. (For more insight, see Introduction to Exchange Traded Funds and An Inside Look At ETF Construction.)
How Is an ETN Different Than an ETF?ETNs are structured products that are issued as senior debt notes by Barclays, while ETFs represent a stake in an underlying commodity. Barclays is a 300-year-old bank with $1.5 trillion in assets and an 'AA' credit rating from Standard & Poor's.
This provides ETNs with a fairly dependable backing, but even with this kind of credibility, ETNs are not free of credit risk - after all, Barclays Bank will never be as safe as a central bank, such as the Bank of England. In the 1990s, for example, Barings Bank (which was as reputable as Barclays, at the time) collapsed as a result of the large losses incurred by a speculative trader employed at the bank.
Since long-term capital gains are treated more favorably than short-term capital gains and interest, the tax treatment of ETNs should be more favorable than that of ETFs. However, as of November 2006, the IRS had not made a definitive ruling on their tax treatment. For international investors, the differences are compounded as treatment for these capital gains and will be treated differently in their home countries. (For related reading, see Capital Gains Tax 101.)
RiskOutside of the tax treatment, the difference between ETNs and ETFs comes down to credit risk vs. tracking risk. ETNs possess credit risk, so if Barclays goes bankrupt, the investor may not receive the return he or she was promised. An ETF, on the other hand, has virtually no credit risk, but there is tracking risk involved with holding an ETF. In other words, there is a possibility that the ETF's returns will differ from its underlying index.
The following chart represents a comparison of the GSCI's ETF and ETN.
Features |
ETN |
ETF |
Issuer |
Barclay's Bank |
Barclay's Global Investor |
Liquidity |
Daily, On Exchange |
Daily, On Exchange |
Registration |
Securities Act of 1933 |
Investment Company Act of 1940 |
Recourse |
Issuer Credit |
Portfolio of Securities |
Principal Risk |
Market and Issuer Risk |
Market Risk |
Institutional Size Redemption |
Weekly, To the Issuer |
Daily Via Custodian |
Short Sales |
Yes, On an Uptick or Downtick |
Yes, On an Uptick or Downtick |
Tracking Error |
No |
Yes |
Expense Ratio |
75 bps |
75 bps |
Source: iShares |
Now that you have a better understanding of the differences between ETN and ETF, which one should prevail? To some degree that will be determined by your tax bracket and your investment time horizon. While the biggest benefit of an ETN is that the entire gain is treated as a capital gain, this gain is also deferred until the security is either sold or matures - something that should not be taken lightly by tax-conscious, long-term investors. With an ETF, capital gains and losses are realized as each futures contract is rolled into another one.
A ruling by the IRS would help remove the tax uncertainty of ETNs. As it stands now, the view that ETNs are classified as prepaid contracts is one that has been made by Barclays and not as an official ruling by the IRS. However, giving taxes higher priority over the quality of an investment can be perilous - the tax code and tax rates are always subject to change.
The absence of tracking risk is also of some value for ETN investors, but it should not be overrated because this has not been a big problem with ETFs. Furthermore, the question of liquidity for ETNs has not yet been answered.
The Bottom LineThe big difference between ETNs and ETFs is credit risk and tax treatment. While much can be made about the counterparty risk of ETNs, is it really any different from the counterparty risk that exists in the structured product and derivatives markets today?
At this point, Barclays has only introduced three ETNs, but their unique structure means that they could be applied to any tradable index. This opens the door for the potential development of many more ETNs in the future, as asset classes like timber, foreign currency bonds, foreign commercial real estate and equity volatility in the U.S still lack an index security.
While the benefit of active management is arguable, there is no disputing the value that financial engineering has brought to the financial markets since deregulation took hold in the early 1970s. Financial engineering has made our markets more liquid and more efficient. The advent of ETN is no different. However, as with any new product, there are unanswered questions.
Read more: http://www.investopedia.com/articles/06/ETNvsETF.asp#ixzz1ygATZVW2
It's important to understand that each mutual fund has different risks and rewards. In general, the higher the potential return, the higher the risk of loss. Although some funds are less risky than others, all funds have some level of risk - it's never possible to diversify away all risk. This is a fact for all investments.
Each fund has a predetermined investment objective that tailors the fund's assets, regions of investments and investment strategies. At the fundamental level, there are three varieties of mutual funds:
1) Equity funds (stocks)
2) Fixed-income funds (bonds)
3) Money market funds
All mutual funds are variations of these three asset classes. For example, while equity funds that invest in fast-growing companies are known as growth funds, equity funds that invest only in companies of the same sector or region are known as specialty funds.
Money Market Funds
The money market consists of short-term debt instruments, mostly Treasury bills. This is a safe place to park your money. You won't get great returns, but you won't have to worry about losing your principal. A typical return is twice the amount you would earn in a regular checking/savings account and a little less than the average certificate of deposit (CD).
Bond/Income Funds
Income funds are named appropriately: their purpose is to provide current income on a steady basis. When referring to mutual funds, the terms "fixed-income," "bond," and "income" are synonymous. These terms denote funds that invest primarily in government and corporate debt. While fund holdings may appreciate in value, the primary objective of these funds is to provide a steady cashflow to investors. As such, the audience for these funds consists of conservative investors and retirees.
Bond funds are likely to pay higher returns than certificates of deposit and money market investments, but bond funds aren't without risk. Because there are many different types of bonds, bond funds can vary dramatically depending on where they invest. For example, a fund specializing in high-yield junk bonds is much more risky than a fund that invests in government securities. Furthermore, nearly all bond funds are subject to interest rate risk, which means that if rates go up the value of the fund goes down.
Balanced Funds
The objective of these funds is to provide a balanced mixture of safety, income and capital appreciation. The strategy of balanced funds is to invest in a combination of fixed income and equities. A typical balanced fund might have a weighting of 60% equity and 40% fixed income. The weighting might also be restricted to a specified maximum or minimum for each asset class.
A similar type of fund is known as an asset allocation fund. Objectives are similar to those of a balanced fund, but these kinds of funds typically do not have to hold a specified percentage of any asset class. The portfolio manager is therefore given freedom to switch the ratio of asset classes as the economy moves through the business cycle.
Funds that invest in stocks represent the largest category of mutual funds. Generally, the investment objective of this class of funds is long-term capital growth with some income. There are, however, many different types of equity funds because there are many different types of equities. A great way to understand the universe of equity funds is to use a style box, an example of which is below.
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The idea is to classify funds based on both the size of the companies invested in and the investment style of the manager. The term value refers to a style of investing that looks for high quality companies that are out of favor with the market. These companies are characterized by low P/E and price-to-book ratios and high dividend yields. The opposite of value is growth, which refers to companies that have had (and are expected to continue to have) strong growth in earnings, sales and cash flow. A compromise between value and growth is blend, which simply refers to companies that are neither value nor growth stocks and are classified as being somewhere in the middle.
For example, a mutual fund that invests in large-cap companies that are in strong financial shape but have recently seen their share prices fall would be placed in the upper left quadrant of the style box (large and value). The opposite of this would be a fund that invests in startup technology companies with excellent growth prospects. Such a mutual fund would reside in the bottom right quadrant (small and growth).
Global/International Funds
An international fund (or foreign fund) invests only outside your home country. Global funds invest anywhere around the world, including your home country.
It's tough to classify these funds as either riskier or safer than domestic investments. They do tend to be more volatile and have unique country and/or political risks. But, on the flip side, they can, as part of a well-balanced portfolio, actually reduce risk by increasing diversification. Although the world's economies are becoming more inter-related, it is likely that another economy somewhere is outperforming the economy of your home country.
This classification of mutual funds is more of an all-encompassing category that consists of funds that have proved to be popular but don't necessarily belong to the categories we've described so far. This type of mutual fund forgoes broad diversification to concentrate on a certain segment of the economy.
Sector funds are targeted at specific sectors of the economy such as financial, technology, health, etc. Sector funds are extremely volatile. There is a greater possibility of big gains, but you have to accept that your sector may tank.
Regional funds make it easier to focus on a specific area of the world. This may mean focusing on a region (say Latin America) or an individual country (for example, only Brazil). An advantage of these funds is that they make it easier to buy stock in foreign countries, which is otherwise difficult and expensive. Just like for sector funds, you have to accept the high risk of loss, which occurs if the region goes into a bad recession.
Socially-responsible funds (or ethical funds) invest only in companies that meet the criteria of certain guidelines or beliefs. Most socially responsible funds don't invest in industries such as tobacco, alcoholic beverages, weapons or nuclear power. The idea is to get a competitive performance while still maintaining a healthy conscience.
Index Funds
The last but certainly not the least important are index funds. This type of mutual fund replicates the performance of a broad market index such as the S&P 500 or Dow Jones Industrial Average (DJIA). An investor in an index fund figures that most managers can't beat the market. An index fund merely replicates the market return and benefits investors in the form of low fees.
What's even more disturbing is the way the fund industry hides costs through a layer of financial complexity and jargon. Some critics of the industry say that mutual fund companies get away with the fees they charge only because the average investor does not understand what he/she is paying for.
Fees can be broken down into two categories:
1. Ongoing yearly fees to keep you invested in the fund.
2. Transaction fees paid when you buy or sell shares in a fund (loads).
The Expense Ratio
The ongoing expenses of a mutual fund is represented by the expense ratio. This is sometimes also referred to as the management expense ratio (MER). The expense ratio is composed of the following:
• The cost of hiring the fund manager(s) - Also known as the management fee, this cost is between 0.5% and 1% of assets on average. While it sounds small, this fee ensures that mutual fund managers remain in the country's top echelon of earners. Think about it for a second: 1% of 250 million (a small mutual fund) is $2.5 million - fund managers are definitely not going hungry! It's true that paying managers is a necessary fee, but don't think that a high fee assures superior performance.
• The last part of the ongoing fee (in the United States anyway) is known as the 12B-1 fee. This expense goes toward paying brokerage commissions and toward advertising and promoting the fund. That's right, if you invest in a fund with a 12B-1 fee, you are paying for the fund to run commercials and sell itself!
On the whole, expense ratios range from as low as 0.2% (usually for index funds) to as high as 2%. The average equity mutual fund charges around 1.3%-1.5%. You'll generally pay more for specialty or international funds, which require more expertise from managers.
Are high fees worth it? You get what you pay for, right?
Wrong.
Just about every study ever done has shown no correlation between high expense ratios and high returns. This is a fact. If you want more evidence, consider this quote from the Securities and Exchange Commission's website:
"Higher expense funds do not, on average, perform better than lower expense funds."
Loads, A.K.A. "Fee for Salesperson"
Loads are just fees that a fund uses to compensate brokers or other salespeople for selling you the mutual fund. All you really need to know about loads is this: don't buy funds with loads.
In case you are still curious, here is how certain loads work:
• Front-end loads - These are the most simple type of load: you pay the fee when you purchase the fund. If you invest $1,000 in a mutual fund with a 5% front-end load, $50 will pay for the sales charge, and $950 will be invested in the fund.
• Back-end loads (also known as deferred sales charges) - These are a bit more complicated. In such a fund you pay the a back-end load if you sell a fund within a certain time frame. A typical example is a 6% back-end load that decreases to 0% in the seventh year. The load is 6% if you sell in the first year, 5% in the second year, etc. If you don't sell the mutual fund until the seventh year, you don't have to pay the back-end load at all.
Mutual Funds: Picking A Mutual Fund
You can buy some mutual funds (no-load) by contacting fund companies directly. Other funds are sold through brokers, banks, financial planners, or insurance agents. If you buy through a third party, you may pay a sales charge (load).
That said, funds can be purchased through no-transaction fee programs that offer funds from many companies. Sometimes referred to as "fund supermarkets," these programs let you buy funds from many different companies. They also provide consolidated recording that includes all purchases made through the supermarket, even if they are from different fund families. Popular examples are Schwab's OneSource, Vanguard's FundAccess, and Fidelity's FundsNetwork. Many large brokerages have similar offerings.
What to Know Before You Shop
Net asset value (NAV), which is a fund's assets minus liabilities, is the value of a mutual fund. NAV per share is the value of one share in the mutual fund, and it is the number that is quoted in newspapers. You can basically just think of NAV per share as the price of a mutual fund. It fluctuates everyday as fund holdings and shares outstanding change.
Finding Funds
Nearly every fund company in the country also has its own website. Simply type the name of the fund or fund company that you wish to learn more about into a search engine and hit “search.” If you don’t have a specific fund company already in mind, you can run a search for terms like “no-load small cap fund” or large-cap value fund.”
For a more organized search, there are a variety of other resources available online. Two notable ones include:
The Mutual Fund Education Alliance is the not-for-profit trade association of the no-load mutual fund industry. They have a tool for searching for no-load funds.
Morningstar is an investment research firm that is particularly well known for its fund information.
Identifying Goals and Risk ToleranceBefore acquiring shares in any fund, you need to think about why you are investing. What is your goal? Are long-term capital gains desired, or is a current income preferred? Will the money be used to pay for college expenses, or to supplement a retirement that is decades away? Identifying a goal is important because it will help you hone in on the right fund for the task.
For really short-term goals, money market funds may be the right choice, For goals that are few years in the future, bond funds may be appropriate. For long-term goals, stocks funds may be the way to go.
Of course, you must also consider the issue of risk tolerance. Can you afford and accept dramatic swings in portfolio value? If so, you may prefer stock funds over bond funds. Or is a more conservative investment warranted? In that case, bond funds may be the way to go.
The next question to consider include “are you more concerned about trying to outperform your fund’s benchmark index or are you more concerned about the cost of your investments?” If the answer is “cost,” index funds are likely the right choice for you.
Mutual Funds: Evaluating Performance
1 year | 3 year | 5 year |
53% | 20% | 11% |
Last year, the fund had excellent performance at 53%. But, in the past three years, the average annual return was 20%. What did it do in years 1 and 2 to bring the average return down to 20%? Some simple math shows us that the fund made an average return of 3.5% over those first two years: 20% = (53% + 3.5% + 3.5%)/3. Because that is only an average, it is very possible that the fund lost money in one of those years.
It gets worse when we look at the five-year performance. We know that in the last year the fund returned 53% and in years 2 and 3 we are guessing it returned around 3.5%. So what happened in years 4 and 5 to bring the average return down to 11%? Again, by doing some simple calculations we find that the fund must have lost money, an average of -2.5% each year of those two years: 11% = (53% + 3.5% + 3.5% - 2.5% - 2.5%)/5. Now the fund's performance doesn't look so good!
It's All Relative
Of course, knowing how a fund performed is only one third of the battle. Performance is a relative issue, literally. If the fund we looked at above is judged against its appropriate benchmark index, a whole new layer of information is added to the evaluation. If the index returned 75% for the 1 year time period, that 53% from the fund doesn't look quite so good. On the other hand, if the index delivered results of 25%, 5%, and -5% for the respective one, three, and five-year periods, then the fund’s results look rather fine indeed.
To add another layer of information to the evaluation, one can consider a fund’s performance against its peer group as well as against its index. If other funds that invest with a similar mandate had similar performance, this data point tells us that the fund is in line with its peers. If the fund bested its peers and its benchmark, its results would be quite impressive indeed.
Looking at any one piece of information in isolation only tells a small portion of the story. Consider the comparison of a fund against its peers. If the fund sits in the top slot over each of the comparison periods, it is likely to be a solid performer. If it sits at the bottom, it may be even worse than perceived, as peer group comparisons only capture the results from existing funds. Many fund companies are in the habit of closing their worst performers. When the "losers" are purged from their respective categories, their statistical records are no longer included in the category performance data. This makes the category averages creep higher than they would have if the losers were still in the mix. This is better known as survivorship bias.
Read more: http://www.investopedia.com/university/mutualfunds/mutualfunds3.asp#ixzz1wWHXgW9s
'529 Plan'
The prepayment may be in the form of a contribution to an account established specifically for paying higher educational expenses. There is no income restriction for individuals who want to contribute to a 529 plan; however, because contributions cannot exceed the amount that sufficiently covers the expenses of the beneficiary's qualified higher education, individuals should take care not to over-fund the 529 plan.529 plans (also known as a "qualified tuition program") were created under the Small Business Job Protection Act of 1996 (SBA '96) as a means of allowing taxpayers to save for higher education expenses for a designated beneficiary. A 529 plan may be provided by a state, an agency of the state or by an educational institution.
Like the education savings account (ESA), the 529 plan is an excellent way to save for education expenses. Earnings accumulate on a tax-deferred basis and distributions that are used for qualified education expenses are tax- and penalty-free. Unlike the ESA, the 529 plan may be set up in a way that allows individuals to prepay a student's qualified higher-education expenses at an eligible educational institution. Also, the contribution limits for a 529 plan are considerably higher than those for an ESA. Here we take a look at 529 plans, how they work and how you can use them to save for a child or grand-child's college education.
- Prepaid tuition programs, which may be offered by the state of an eligible educational institution. Prepaid tuition programs allow for the advance purchase of credits for the designated beneficiary. These are usually established during enrollment periods established by the state of the eligible educational institution.
- College savings plans allow contributions to be made to the account on behalf of the designated beneficiary. These can usually be established at any time, including immediately after the designated beneficiary is born.
The designated beneficiaryunder a 529 plan is the student the plan is established for. The designated beneficiary can be changed to an eligible person. Typically, the designated beneficiary is changed if the current designated beneficiary will not need the funds in the 529 plan for eligible education expenses. If a state or local government or certain tax-exempt organizations purchase an interest in a 529 plan as part of a scholarship program, the designated beneficiary is the person who receives the interest as a scholarship.
Certain educational institutions located outside the United States also participate in the U.S. Department of Education's Federal Student Aid (FSA) programs.
Individuals should check with the educational institution to determine if it is an eligible education institution for 529 plan purposes.
529 Plans: Eligibility
Who Can Establish and Contribute to the 529 Plan?
Anyone
can establish and contribute to a 529 plan on behalf of a designated
beneficiary. This means that relatives, family, friends and even the
designated beneficiary can establish the 529 plan for him- or herself.
But the rules do vary. For instance, some 529 plans limit participation
to residents of the state while others allow anyone to participate,
regardless of the individual's state of residence. Individuals should
check with the financial institution or the education institution providing the plan to determine the eligibility requirements for establishing an account under the plan.
Some 529 plans may have established enrollment periods before which new accounts must be opened.
Age and Income Requirements
Unlike the ESA, 529 plans
do not have income restrictions. Some 529 plans - although there are
very few - place age restrictions on designated beneficiaries.
Individuals must check with the plan provider and the plan documents to
determine whether there are any restrictions that apply to the 529 plan
they want to establish for the designated beneficiary.
Change in the Designated Beneficiary
Like the ESA, the 529 plan allows the designated beneficiary to be changed to a qualified family member who meets any age requirements as determined by the plan.
For the purpose of determining who can become a designated beneficiary of a 529 plan, a qualified family member includes the following:
- The designated beneficiary's spouse
- The designated beneficiary's son or daughter or descendant of the beneficiary's son or daughter
- The designated beneficiary's stepson or stepdaughter
- The designated beneficiary's brother, sister, stepbrother or stepsister
- The designated beneficiary's father or mother, or ancestor of either parent
- The designated beneficiary's stepfather or stepmother
- The designated beneficiary's niece or nephew
- The designated beneficiary's aunt or uncle
- The spouse of any individual listed above, including the beneficiary's son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law
- Any individual for whom the home of the designated beneficiary is his or her primary home for the entire tax year
- The designated beneficiary's first cousin
Anyone can establish and contribute to a 529 plan on behalf of a designated beneficiary. This means that relatives, family, friends and even the designated beneficiary can establish the 529 plan for him- or herself. But the rules do vary. For instance, some 529 plans limit participation to residents of the state while others allow anyone to participate, regardless of the individual's state of residence. Individuals should check with the financial institution or the education institution providing the plan to determine the eligibility requirements for establishing an account under the plan.
Some 529 plans may have established enrollment periods before which new accounts must be opened.
Age and Income Requirements
Unlike the ESA, 529 plans do not have income restrictions. Some 529 plans - although there are very few - place age restrictions on designated beneficiaries. Individuals must check with the plan provider and the plan documents to determine whether there are any restrictions that apply to the 529 plan they want to establish for the designated beneficiary.
Change in the Designated Beneficiary
Like the ESA, the 529 plan allows the designated beneficiary to be changed to a qualified family member who meets any age requirements as determined by the plan.
For the purpose of determining who can become a designated beneficiary of a 529 plan, a qualified family member includes the following:
- The designated beneficiary's spouse
- The designated beneficiary's son or daughter or descendant of the beneficiary's son or daughter
- The designated beneficiary's stepson or stepdaughter
- The designated beneficiary's brother, sister, stepbrother or stepsister
- The designated beneficiary's father or mother, or ancestor of either parent
- The designated beneficiary's stepfather or stepmother
- The designated beneficiary's niece or nephew
- The designated beneficiary's aunt or uncle
- The spouse of any individual listed above, including the beneficiary's son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law
- Any individual for whom the home of the designated beneficiary is his or her primary home for the entire tax year
- The designated beneficiary's first cousin
529 Plans: Contributions
Regular contributions to 529 plans must be made in cash (which includes checks). In-kind contributions, such as stocks, bonds, mutual funds or other non-cash items cannot be used to make regular contributions to and cannot be made in the form of securities.
Contribution LimitThe
maximum amount that may be contributed on behalf of each designated
beneficiary varies among states. Typically, contributions to each plan
are limited to amounts that are necessary to finance
the designated beneficiary's eligible education expenses. Where limits
are established, they are usually applied on a lifetime basis. For
instance, a plan may limit total contributions to $200,000, which is the
maximum total that can be contributed to the designated beneficiary's
529 account over time.
Amounts contributed to a designated
beneficiary's 529 account are treated as a gift. However, contributions
of up to $13,000 can be made for each designated beneficiary without
incurring federal gift tax
in accordance with the annual exclusion applies to gifts to each done.
Alternatively, an individual may be able to contribute a lump sum that
covers five years, giving a total of $65,000 ($130,000 for married
couples), provided the individual makes no additional gifts to that
designated beneficiary for the five-year period.
Rollovers, Transfers, Changing Designated Beneficiaries
If a designated beneficiary no longer wants or needs the balance in his or her 529 plan, the amount can be given to an eligible family member. For this purpose, eligible family members include the following:
- The designated beneficiary's spouse
- The designated beneficiary's son or daughter or descendant of the beneficiary's son or daughter
- The designated beneficiary's stepson or stepdaughter
- The designated beneficiary's brother, sister, stepbrother or stepsister
- The designated beneficiary's father or mother, or ancestor of either parent
- The designated beneficiary's stepfather or stepmother
- The designated beneficiary's niece or nephew
- The designated beneficiary's aunt or uncle
- The spouse of any individual listed above, including the beneficiary's son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law
- Any individual for whom the home of the designated beneficiary is his or her primary home for the entire tax year
- The designated beneficiary's first cousin
Tax Deduction AllowanceSome states' 529 plan rules allow taxpayers to receive a tax deduction for contributions, but there may be certain requirements. For instance, while a state's 529 plan may allow anyone (regardless of his or her state of residence) to participant in its 529 plan, only residents of the state may be allowed a tax deduction for the contributions. Individuals must check with the particular plan to determine its features and benefits.
The investment choices for 529 plans are usually limited to mutual funds or annuities. For some plans, the investment choices are based on the age of the beneficiary, allowing more aggressive investments for younger beneficiaries.
Read more: http://www.investopedia.com/university/retirementplans/529plan/529plan3.asp#ixzz1yg97seKT
529 Plans: Distributions
Distributions from 529 plans used for qualified education expenses are tax- and penalty-free if the amount is equal to or less than the designated beneficiary's qualified education expenses. For distributions that are more than the individual's qualified education expenses, the earnings may be subject to tax and an additional 10% early-distribution penalty. Some states allow qualified individuals, as defined by the state, to claim tax deductions for contributions they make to 529 plans. If a tax deduction is allowed, state taxes may also apply to a distribution of amounts other than earnings.
Qualified Education ExpensesGenerally, qualified education expenses include the following:
- Expenses required for the designated beneficiary's enrollment in and attendance at an eligible school. Eligible schools include colleges, universities, vocational schools and accredited post-secondary educational institutions that are eligible to participate in a student aid program administered by the Department of Education.
- Tuition and fees
- Books, supplies and equipment
- Academic tutoring
- Room and board
- Uniforms
- Transportation
- Expenses of a special needs beneficiary that are necessary for that person's enrollment or attendance at an eligible educational institution.
- The designated beneficiary dies, and the distribution goes to another beneficiary or to the estate of the designated beneficiary.
- The designated beneficiary becomes disabled. A person is considered disabled if there is proof that he or she cannot do any substantial gainful activity because of a physical or mental condition. A physician must determine that the individual's condition can be expected to result in death or continue indefinitely.
- The designated beneficiary receives any of the following:
- a qualified scholarship excludable from gross income
- veterans' educational assistance
- employer-provided educational assistance
- any other nontaxable payments (other than gifts, bequests or inheritances) received for education expenses
- The distribution is included in income only because the qualified education expenses were taken into account in determining the Hope Credit or Lifetime Learning Credit, both of which are tax credits that reduce the amount of taxable income for an individual funding a student's education.
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529 Plans: Conclusion
Similar to the education savings account (ESA), the 529 plan is an excellent way to save for education expenses.Let's recap:
- 529 plans allow for the prepayment of qualified higher-education expenses at eligible educational institutions.
- There are no income restrictions for individuals who want to contribute to a 529 plan; however, because contributions cannot be more than the amount necessary to provide for the qualified higher-education expenses of the beneficiary, individuals should take care not to contribute too much to the 529 plan.
- An individual may contribute up to $13,000 each year to a designated beneficiary’s 529 plan without incurring federal gift tax, provided that the individual makes no additional gifts to that designated beneficiary for the year.
- The distribution from the 529 plan may be used for:
- tuition and fees
- books, supplies and equipment
- academic tutoring
- room and board
- uniforms
- transportation