Special Types of Accounts

Special Types of Accounts

Beyond standard taxable brokerage and retirement accounts, the Series 66 expects working command of specialized account structures used in tax-advantaged savings, custodial holdings, healthcare funding, and ownership arrangements. Five sections: education savings (529 plans, Coverdell ESAs, ABLE accounts) anchored by a 529-vs-taxable savings comparator; custodial accounts (UTMA/UGMA) and the kiddie tax; health-related accounts (HSA, FSA, HRA); joint and individual account ownership (JTWROS, TIC, TBE, community property, TOD/POD); and trust accounts (revocable, irrevocable, grantor, special needs). This chapter is canonical for account MECHANICS — M3.10 covers estate-planning applications of these same accounts.

529 plans — mechanics, qualified expenses, recent changes

State-sponsored education savings plans (qualified tuition programs under IRC Section 529). Two varieties: SAVINGS PLANS (investment account that grows tax-free) and PREPAID TUITION PLANS (locks in current tuition rates). Most modern plans are savings plans.

• Tax treatment. Contributions are NOT federally tax-deductible. Many states offer a STATE INCOME TAX DEDUCTION (typically only for contributions to that state's plan). Earnings grow TAX-FREE if used for qualified expenses. Non-qualified withdrawals are taxed as ordinary income on EARNINGS only, plus a 10% penalty.
• Qualified expenses. Tuition, fees, room and board, books, computers, internet, and certain equipment at accredited post-secondary institutions. K-12 TUITION (private/religious school) up to $10,000/year per beneficiary. Student loan repayment up to $10,000 lifetime per beneficiary.
• No income limit on contributors. Unlike Coverdell, anyone at any income can contribute. No federal contribution limit (state-specific lifetime caps, often $300K-$550K).
• Gift tax 5-year election. A donor can front-load 5 years of annual exclusion in one contribution (~$90K single, $180K married couple), treated as 5 annual gifts. Critical estate-planning tool.
• Beneficiary changes. The account owner can change beneficiaries to any other “family member” (broadly defined) at any time without tax consequences. The owner retains control — not an irrevocable gift to the beneficiary.
• SECURE 2.0 529-to-Roth rollover. Unused 529 funds can be rolled into the BENEFICIARY'S (not owner's) Roth IRA. Conditions: 529 open at least 15 YEARS; lifetime limit $35,000; subject to annual Roth contribution limits; beneficiary must have earned income.

Coverdell Education Savings Accounts

Coverdell ESAs (formerly Education IRAs) are tax-advantaged savings accounts for qualified education expenses. They overlap with 529 plans in some respects but differ in important ways:

• Contribution limit: $2,000 per BENEFICIARY (not per account) per year, aggregated across all Coverdells for the same beneficiary. Significantly lower than 529 limits.
• Income limits on contributors. Contributions phase out at MAGI $95K-$110K single / $190K-$220K MFJ. High earners can't contribute directly — though anyone (including grandparents) can contribute below those thresholds.
• Tax treatment. Contributions NOT deductible. Earnings grow tax-free; withdrawals tax-free if used for qualified education expenses.
• Qualified expenses are BROADER than 529. Includes K-12 expenses for tuition, uniforms, supplies, tutoring, transportation, room and board, equipment — not just tuition. This is the historical advantage of Coverdell over 529 (though 529 now allows $10K/year for K-12 tuition specifically).
• Age restrictions. Contributions only until beneficiary turns 18; funds must be used or rolled to another family member by age 30. (Disabled beneficiaries are exempt from age limits.)
• Investment flexibility. Coverdell allows self-directed investments (individual securities, mutual funds, ETFs). Some 529 plans limit investment choices to age-based portfolios.

For most families, 529 wins on contribution limits and donor flexibility. Coverdell wins on investment self-direction and broader K-12 expense definition.

ABLE accounts (529A) — for disabled beneficiaries

ABLE accounts (Achieving a Better Life Experience), authorized under IRC Section 529A, are tax-advantaged savings accounts for INDIVIDUALS WITH DISABILITIES. Created by the ABLE Act of 2014 to provide a savings vehicle that doesn't disqualify the beneficiary from means-tested government benefits (SSI, Medicaid).

• Eligibility. Beneficiary must have a qualifying disability that began before age 26 (rising to 46 in 2026 under SECURE 2.0). Recognized via SSDI/SSI status or physician's certification.
• Contribution limit. Up to the annual federal gift tax exclusion (~$18K-19K in recent years) per year from all sources combined. Working beneficiaries can contribute additional amounts up to specific limits (the ABLE to Work provision).
• Tax treatment. Contributions NOT federally deductible (many states offer state deduction). Earnings grow tax-free; withdrawals for QUALIFIED DISABILITY EXPENSES (housing, transportation, education, healthcare, assistive technology, employment training, etc.) are tax-free.
• Means-tested benefit preservation. Critically: ABLE account balances up to $100,000 are EXCLUDED from SSI resource calculations. (Balances above $100K can affect SSI but not Medicaid.) This is the central advantage over UTMA/UGMA, which would disqualify the beneficiary from means-tested benefits.
• Medicaid payback. Upon beneficiary's death, remaining ABLE funds may be subject to Medicaid claim (Medicaid “claw-back”) for benefits provided during the beneficiary's lifetime — before any remaining funds pass to heirs.
• One ABLE per beneficiary. Each disabled individual can have only one ABLE account at a time.

The Series 66 testable point: ABLE accounts protect means-tested benefit eligibility in a way that no other custodial or savings account structure can. For families of disabled individuals, ABLE is often the preferred vehicle.

UTMA vs. UGMA — the custodial account distinction

Both UTMA (Uniform Transfers to Minors Act) and UGMA (Uniform Gifts to Minors Act) are state-law frameworks for adults to give property to minors under custodial management. The Series 66 tests distinctions:

• UGMA (older, 1956 originally). Permits gifts of CASH, SECURITIES, INSURANCE policies, and ANNUITIES only. The custodian manages until the minor reaches the age of majority — usually 18 or 21 depending on state.
• UTMA (newer, 1986). Permits gifts of ANY KIND OF PROPERTY — including REAL ESTATE, art, royalties, fine collectibles, partnership interests. Broader scope than UGMA. Most states have adopted UTMA; some still recognize UGMA.
• Age of majority varies by state. Common: 18 (UGMA), 21 (UTMA), some states allow extension to 25 with specific designation at account creation.
• Irrevocable gift. Once contributed, the funds belong to the minor. The donor cannot reclaim them. The custodian has a fiduciary duty to manage solely for the minor's benefit.
• Transfer at age of majority. When the minor reaches the age of majority, they receive FULL UNRESTRICTED CONTROL of the assets. The custodian cannot extend the custodianship or restrict use. This is a primary disadvantage of UTMA/UGMA versus trusts — the 18- or 21-year-old can spend the assets on anything.
• Tax treatment. Account belongs to the minor for tax purposes. Investment income is reported on the minor's return — subject to KIDDIE TAX rules below.

Compare to ABLE accounts (preserves means-tested benefits) and 529 plans (account owner retains control) which solve specific limitations of UTMA/UGMA.

Kiddie tax — thresholds and mechanics

The KIDDIE TAX rules tax a child's UNEARNED INCOME (interest, dividends, capital gains) above a threshold at the PARENTS' marginal rate, rather than the child's typically-lower rate. Designed to prevent income-shifting strategies that move investment income from high-bracket parents to low-bracket children.

2024 kiddie tax brackets (indexed annually):

• First ~$1,300 of unearned income: tax-free (covered by the dependent's standard deduction).
• Next ~$1,300: taxed at the CHILD'S rate (typically 10%).
• Above ~$2,600: taxed at the PARENTS' marginal rate — the kiddie-tax kick-in.

Who is subject to kiddie tax:

• Children UNDER AGE 19 (or under 24 if a full-time student providing less than half their own support)
• The child must have a living parent with whom they can be compared (otherwise standard individual rates apply)
• The child must have at least one parent (typically the parent with higher income for tax purposes)

Planning implications: UTMA/UGMA accounts that exceed the ~$2,600 unearned-income threshold are taxed less favorably than originally intended (the parents' high rate applies to most of the income anyway). For sophisticated families, 529 plans and ABLE accounts often outperform UTMA on a tax basis. UTMA is best for relatively small gifts or where the asset-transfer flexibility (any property type, including real estate or collectibles) matters more than tax optimization.

HSAs — the triple-tax-advantaged savings vehicle

Health Savings Accounts (HSAs) are tax-advantaged savings accounts paired with HIGH-DEDUCTIBLE HEALTH PLANS (HDHPs). HSAs uniquely offer THREE distinct tax benefits — making them the most powerful tax-advantaged savings vehicle in the US tax code when used optimally.

• Triple tax advantage: (1) contributions are tax-DEDUCTIBLE (or pre-tax through payroll); (2) earnings grow TAX-FREE; (3) qualified withdrawals for medical expenses are TAX-FREE. No other vehicle offers all three.
• Eligibility. Must be enrolled in a qualifying HDHP, not be covered by other non-HDHP health insurance, not be enrolled in Medicare, and not be claimed as a dependent on another taxpayer's return.
• Contribution limits (2024). Self-only HDHP coverage: $4,150. Family HDHP coverage: $8,300. Catch-up for age 55+: additional $1,000.
• Triple tax advantage requires QUALIFIED medical use. Non-qualified withdrawals before age 65 face ordinary income tax PLUS a 20% penalty. After age 65, non-qualified withdrawals face ordinary income tax but NO penalty — making HSAs effectively a supplemental retirement account once Medicare-eligible.
• HSA “ratchet” strategy. Sophisticated HSA users pay medical expenses out-of-pocket (with after-tax dollars), keeping receipts, and let the HSA grow tax-free indefinitely. Decades later, they reimburse themselves (tax-free) for the long-ago medical expenses, effectively converting HSA growth into tax-free retirement income.
• Portable. Belongs to the individual, not the employer. Unused balances roll over year to year (unlike FSAs); HSA persists across employers and into retirement.

FSA, HRA, and HSA — healthcare account comparison

Three healthcare-related accounts are often confused. The Series 66 tests their key distinctions:

Key exam framings: (1) HSA is portable and unlimited rollover; FSA is “use it or lose it.” (2) HSA requires HDHP enrollment; FSA and HRA do not. (3) HRA is employer-only funded; HSA and FSA accept employee contributions. (4) Only HSA has the triple tax advantage of deduction, tax-free growth, and tax-free withdrawal.

JTWROS and Tenancy in Common — the two main joint account structures

Most joint brokerage accounts fall into one of two categories:

• Joint Tenants with Right of Survivorship (JTWROS). Each owner holds an undivided interest in the WHOLE account. Upon the death of one owner, the deceased owner's interest passes AUTOMATICALLY to the surviving owner(s) — BYPASSING PROBATE entirely. No will or beneficiary designation can override the right of survivorship. Common between spouses; also used between parents and adult children.
• Tenancy in Common (TIC). Each owner holds a SPECIFIED FRACTIONAL SHARE (typically 50/50 but can be any percentage). Upon the death of one owner, that owner's share passes through their estate via WILL OR INTESTATE SUCCESSION — goes through probate, governed by the decedent's estate plan. No automatic survivorship. The surviving co-tenant has no special claim to the decedent's share.

Key distinctions:

• JTWROS = automatic survivorship + bypasses probate. TIC = no survivorship + passes through estate.
• JTWROS owners typically have equal undivided interests (no fractional split). TIC owners hold specified fractions.
• JTWROS terminates if any owner unilaterally severs. An owner can convert JTWROS to TIC by transferring their interest to themselves — useful for divorce or breakup of co-tenants.
• Tax basis at death. For JTWROS between spouses in non-community-property states, half of the account receives a step-up in basis (the deceased spouse's half). In community-property states, BOTH halves step up.

The most-tested exam point: JTWROS bypasses probate; TIC does not. Choice of joint titling has significant estate-planning consequences.

Tenancy by the Entirety and Community Property

Two more specialized forms of joint ownership apply in specific circumstances:

• Tenancy by the Entirety (TBE). A form of joint ownership available ONLY TO MARRIED COUPLES in certain states (about half of US states). Functions like JTWROS (automatic survivorship, bypasses probate) PLUS adds CREDITOR PROTECTION: a creditor of one spouse generally CANNOT reach TBE-titled property — only joint creditors can. Particularly valuable for professionals at risk of malpractice suits. Terminated by divorce (automatically converts to TIC) or sale by both spouses.
• Community Property. A property-ownership framework in 9 STATES: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin. (Alaska and Tennessee permit opt-in community property by election.) In community property states, most property acquired DURING MARRIAGE is owned 50/50 by both spouses regardless of whose income produced it. Property owned BEFORE marriage and certain gifts and inheritances are separate property.

Community property step-up advantage. Upon death of one spouse, BOTH halves of community property receive a step-up in basis (versus only the deceased spouse's half in JTWROS in common-law states). This can be substantial for highly appreciated assets. Sophisticated families may move appreciated assets to community property states to capture the full step-up.

Common-law states vs community property states handle marital property fundamentally differently. The exam testable point: 9 states are community property; community property gets DOUBLE step-up; most other states use common law with separate-property defaults.

TOD and POD designations — probate avoidance for individual accounts

TRANSFER ON DEATH (TOD) and PAYABLE ON DEATH (POD) designations let the owner of an INDIVIDUAL (single-name) account name a beneficiary who receives the account directly at death — bypassing probate.

• TOD applies to securities accounts. Brokerage accounts can use TOD to designate beneficiaries who receive the account upon owner's death. The Uniform Transfer on Death Securities Registration Act has been adopted by all 50 states.
• POD applies to bank accounts and CDs. Similar mechanism for bank deposit accounts.
• Operates by contract, not by will. TOD/POD designations OVERRIDE the will — if a will leaves the brokerage account to one beneficiary and the TOD designation names another, the TOD wins. This is a common estate-planning oversight.
• No control during life. The beneficiary has no rights to the account during the owner's lifetime. The owner can freely add, change, or remove the TOD beneficiary without notice. Beneficiary's interest is purely a future contingent right.
• Step-up in basis still applies. Assets transferred via TOD receive the same step-up in basis as inherited property generally — FMV at date of death.
• Multiple beneficiaries permitted. Owner can designate multiple TOD beneficiaries with specified percentages. Contingent beneficiaries (if primary predeceases) can also be named.

TOD/POD is the SIMPLEST and CHEAPEST probate-avoidance mechanism for individual accounts — no trust documentation, no court involvement, just a designation form filed with the custodian. Compare to revocable living trusts (more flexibility, higher cost) and JTWROS (requires co-owner during life with associated complications).

Revocable vs. irrevocable trusts

A trust is a legal entity that holds property for the benefit of named BENEFICIARIES, managed by a TRUSTEE according to the terms of a TRUST DOCUMENT created by the GRANTOR (also called settlor or trustor). The fundamental distinction:

• REVOCABLE (living) trust. Grantor retains the power to MODIFY OR REVOKE the trust at any time during life. Assets remain part of grantor's estate for tax and creditor purposes (no asset protection). Primary use: probate avoidance and incapacity planning. Upon grantor's death, the trust typically becomes irrevocable and distributes per the trust terms.
• IRREVOCABLE trust. Grantor SURRENDERS the power to modify or revoke. Assets are removed from the grantor's estate — provides ESTATE TAX REDUCTION and CREDITOR PROTECTION. Trade-off: grantor permanently loses control. Common types: life insurance trusts (ILITs), GRATs, dynasty trusts, special needs trusts (next block), Medicaid-planning trusts.

Key planning trade-offs:

• Revocable trust = flexibility, no asset protection. The grantor can still spend, modify, or revoke at any time. Estate tax benefits: NONE. Creditor protection: NONE.
• Irrevocable trust = asset protection + estate tax reduction, but permanent. Assets gifted to an irrevocable trust are out of the grantor's estate; protected from grantor's creditors (subject to fraudulent transfer rules and look-back periods).
• Probate avoidance. BOTH revocable and irrevocable trusts avoid probate — that benefit is shared.

Revocable trusts are popular for middle-class families wanting probate avoidance and incapacity protection. Irrevocable trusts are for higher-net-worth families seeking estate tax benefits or specific protections (asset shielding, special needs).

Grantor trust — the income tax classification

Federal income tax classifies trusts as either GRANTOR or NON-GRANTOR for income tax purposes. The classification determines who pays tax on trust income — the grantor (for grantor trusts) or the trust/beneficiaries (for non-grantor trusts).

• Grantor trust. Income is taxed to the GRANTOR personally as if the trust didn't exist. The grantor reports trust income on their individual return. All REVOCABLE trusts are grantor trusts by definition. Some IRREVOCABLE trusts can also be grantor trusts based on specific powers retained by the grantor.
• Non-grantor trust. The trust is a SEPARATE TAXPAYER. Income retained by the trust is taxed to the trust at COMPRESSED rates — trust tax brackets compress dramatically, reaching the top rate at very low income (around $15K). Income DISTRIBUTED to beneficiaries is taxed to the BENEFICIARIES, not the trust (DNI distribution).
• Why grantor trust status matters. When trust income is taxed to the grantor (who likely has a lower marginal rate than the trust's compressed brackets), more money stays in the trust for beneficiaries. This is the “intentionally defective grantor trust” (IDGT) strategy — trust is irrevocable for estate-tax purposes but grantor pays the income tax, effectively making additional tax-free gifts to the trust.
• Trust tax bracket compression. 2024 trust top federal rate (37%) reaches at ~$15,200 of trust income. Compare to single filers reaching 37% at ~$609K. Holding income inside a non-grantor trust often produces the WORST tax outcome — most non-grantor trusts distribute all income annually to beneficiaries at their lower rates.

Special needs trusts — preserving means-tested benefits

SPECIAL NEEDS TRUSTS (SNTs, also called supplemental needs trusts) hold assets for the benefit of a DISABLED INDIVIDUAL in a way that preserves the individual's eligibility for means-tested government benefits (SSI, Medicaid). Without an SNT, assets above SSI/Medicaid resource limits (typically $2,000) disqualify the individual from benefits.

• First-party SNT (self-settled, “d4A” trust). Funded with the DISABLED INDIVIDUAL'S OWN assets (typically a settlement, inheritance received directly, etc.). Must be established before age 65. Trust terms allow distributions for supplemental needs not covered by Medicaid/SSI. Upon beneficiary's death, REMAINING ASSETS must reimburse Medicaid for benefits provided (the “payback” requirement).
• Third-party SNT. Funded with assets from someone OTHER than the disabled beneficiary — typically parents or relatives planning ahead. NO MEDICAID PAYBACK upon beneficiary's death; remaining assets distribute to designated remainder beneficiaries. The preferred structure when families plan in advance.
• Pooled trust (“d4C” trust). Operated by a nonprofit organization; multiple individual sub-accounts pooled for investment but accounted separately. Useful for smaller asset amounts or where professional trust management is needed.

Key feature of all SNTs: the disabled beneficiary CANNOT have control over distributions. The trustee has discretion to distribute for SUPPLEMENTAL needs (not basic support, which is what SSI/Medicaid provides). Distributions must not be made in ways that would be counted as income or resources of the beneficiary for benefits purposes — e.g., paying directly to vendors rather than to the beneficiary.

Compare with ABLE accounts (Section 1): ABLE allows the disabled individual to have direct control of small balances (under $100K excluded from SSI); SNT requires trustee control but has no asset cap. Many families use BOTH in combination.

Education accounts — baseline summary

529 Plans

• State-sponsored education savings plans
• Contributions are NOT federally tax-deductible, but many states offer state tax deductions
• Earnings grow tax-free if used for qualified education expenses
• Qualified expenses include tuition, room and board, books, and up to $10,000/year for K-12 tuition
• Under SECURE Act 2.0, unused 529 funds can be rolled to the beneficiary's Roth IRA (lifetime $35K limit; 529 open 15+ years)
• Non-qualified withdrawals taxed as ordinary income on earnings plus 10% penalty

Coverdell ESA

• $2,000 annual contribution limit per beneficiary (low compared to 529)
• Income limits on contributors (phased out at higher MAGI)
• Broader qualified-expense definition including K-12 supplies, tutoring, transportation
• Self-directed investments permitted
• Funds must be used by age 30 (unless disabled beneficiary)

Custodial and health savings accounts — baseline

UTMA/UGMA Accounts

• Custodial accounts for minors
• Assets are an IRREVOCABLE GIFT to the minor
• Custodian manages until the minor reaches the age of majority (18 or 21 depending on state)
• Investment income subject to KIDDIE TAX — unearned income above a threshold taxed at parents' marginal rate
• UTMA permits any property type (real estate, art); UGMA is limited to cash, securities, insurance, annuities

Health Savings Accounts (HSAs)

• Available only to participants in High-Deductible Health Plans (HDHPs)
• TRIPLE TAX ADVANTAGE: tax-deductible contributions, tax-free growth, tax-free withdrawals for qualified medical expenses
• Unused balances roll over indefinitely; portable across employers
• After age 65, non-medical withdrawals face ordinary income tax but no penalty
• 2024 contribution limits: $4,150 self-only / $8,300 family / $1,000 age-55+ catch-up

529 plans vs. Coverdell ESAs — complete comparison

UTMA/UGMA — the kiddie tax issue

Custodial accounts present a tax trap that advisers must understand:

• Assets are an IRREVOCABLE GIFT to the minor — once contributed, the gift cannot be taken back
• The custodian has a fiduciary duty to manage for the minor's benefit
• Kiddie tax rules. For children under age 19 (or under 24 if a full-time student): first ~$1,300 of unearned income is tax-free; next ~$1,300 taxed at child's rate; above ~$2,600 taxed at PARENTS' marginal rate
• Custodian transfers full unrestricted control to the minor at age of majority (18 or 21 depending on state)
• Counted as the student's asset for FAFSA financial-aid purposes — reduces aid eligibility more than parental assets would
• Investment income often defeats the original tax-shifting purpose once it exceeds the kiddie-tax threshold

Modern alternatives often outperform UTMA/UGMA for tax purposes: 529 plans for education savings (account owner retains control); ABLE accounts for disabled beneficiaries (preserves means-tested benefits); irrevocable trusts for asset protection and customized terms.