529 College Planning: 102

Financial Planning Dentist

Types of 529 plans

This is one of the largest hang-ups for savers. A history of misinformation and contamination between different types of 529s has generated several misnomers. Simply put: 529 plans are usually categorized as “prepaid tuition” or “college savings plans.”

Our favorite of the two is the college savings plan, and we find that several of the misconceptions that savers have come from the “prepaid” tuition plans.   

For clarity, College Savings Plans work much like a Roth 401(k) or Roth IRA. They are investments made with post-tax dollars (that often carry tax benefits) and the accounts grow and earn income in a tax-free way. These accounts allow you to invest your after-tax contributions in mutual funds or similar investments. Most of the 529 college savings plans we work with offer several investment options from which to choose. The performance of the account will be tied to the investment options you chose, and you should consult a CFP® and your InSight-Full® to manage this risk, and coordinate it with your timing of needs.

The other alternative, a Prepaid Tuition Plan,  lets you pre-pay all or part of the costs of an in-state public college education. They may also be converted for use at private and out-of-state colleges. The Private College 529 Plan is a separate prepaid plan for private colleges, sponsored by more than 250 private colleges. These programs are limited in scope, while they can support savers concerned with the rising costs of tuition, they are generally less flexible and have fewer payment and conversion options. They may also carry unique liquidity issues should you plan to change. It is an educational institution that can offer a prepaid tuition plan but not a college savings plan.

What can’t I use my 529 plan for?

The funds and the investments in a 529 plan are yours. You should be able to maneuver and control the funds in the account as you see fit and within your fiduciary scope. Also, you can always withdraw them for any purpose but should be mindful of the consequences.

Chief among these is the earnings portion of a non-qualified distribution will be subject to ordinary income taxes and a 10% tax penalty, though there are exceptions and methods for managing this tax loss.

At the college or post-secondary level, we discussed in “529: 101” the obviously covered costs of education and what the 529s have been expanded to include. Though you should be made aware that there are some costs that you may believe are necessary, but the IRS disagrees. For example, student health insurance and transportation costs are not qualified expenses, unless the college has lines out these associated costs in fees or services from the college. So, parking fees at Denver University campuses might be covered, but a space in a parking lot near campus might not be.

Are 529 plan contributions tax-deductible?

Unfortunately, the 529 is funded with post-tax dollars, and there is no federal tax relief yet. However, here in Colorado and in over 30 other states, they offer state income tax deductions for contributions to 529 plans. But it’s likely that like Colorado, you would be restricted to investing in your home state’s 529 plan in order to claim the state income tax benefit. (Consult a tax professional for more information)

The tax advantage regarding federal taxes comes when the funds in a 529 plan grow. The growth in these plans is federally tax-free and will not be taxed when the money is withdrawn for qualified education expenses.

Can I use a 529 plan to pay for rent?

Yes, with some restrictions. Room and board is now a qualified expense for at least “half-time” or greater students. Consult with the institution for what constitutes a half-time student. 

So for on-campus residents, qualified room-and-board expenses should not exceed the amount charged by the college for room and board. So in this case savers pay the room and board directly to the student housing authority to avoid mismanagement. 

For students living off-campus, qualified room and board expenses are limited to the cost of attendance figures that vary from school to school. Contact the financial aid office for their reports on this figure. In these cases, try to find a 529 fund that supports payment directly to landlords.

What happens if my child doesn’t use the 529 plan?

There are always options for these funds. Hopefully, you are in this situation for a positive reason like a full-ride scholarship or attendance at a service academy. There are a few reasons to seek a waiver however, your earnings will still be subject to federal and sometimes state income tax. If this is the case the 10% penalty is waived if:

  • The beneficiary receives a tax-free scholarship
  • The beneficiary attends a U.S. Military Academy
  • The beneficiary dies or becomes disabled

If you want to avoid paying taxes completely you can resort to the following:

  • Change the beneficiary to another qualifying family member (a parent, child, sibling etc.)
  • Hold the funds in the account in case the beneficiary wants to attend grad school later
  • Make yourself the beneficiary and further your own education
  • Use a 529 ABLE account, a savings account specifically for people living with disabilities
  • Since January 1, 2019, qualified distributions from a 529 plan can repay up to $10,000 in student loans per borrower over their lifetime for both the beneficiary and the beneficiary’s siblings

As we said at the top of this article. you can withdraw any of the money in a 529 plan at any time for any reason. However, the earnings portion of a non-qualified withdrawal will be subject to taxes and a penalty. So in the absence of one of the exceptions listed above, we will usually coach our clients to find one of the other alternatives above and make these necessary changes to their InSight-Full® plan. If you are still contemplating a non-qualified distribution, be aware of the rules and possible tactics for reducing taxes owed.

What happens if the monthly commitment becomes too much for me?

Stop. We frequently have discussions with clients about not making a 529 commitment before the rest of their financial house is in order. Some of the plans have minimum initial contribution requirements but beyond that, the commitment and regularity are entirely up to you. While some families prefer to set up automated monthly deposits because they want to “set it and forget it”, others choose to make lump sum contributions around birthdays, holidays, or other occasions. These details are entirely manageable and part of the maintenance work from a financial plan.

More related articles:

Kevin Taylor

Overview of tax documents and when to use them

Common Tax Documents: W-2 Form: Issued by employers to employees, showing wages earned and taxes withheld throughout the year. Used for reporting income on personal tax returns. 1099 Forms: Various types including: 1099-INT: Reports interest income earned from bank accounts. 1099-DIV: Reports dividend income from investments. 1099-MISC: Reports miscellaneous income, such as freelance earnings or rent payments. 1099-R: Reports distributions from retirement accounts. 1098 Form: 1098 Mortgage Interest Statement: Shows mortgage interest paid during the year, used for deducting mortgage interest on tax returns. Bank and Investment Statements: Summarizes interest, dividends, and capital gains earned from bank accounts, brokerage accounts, and investment funds. Property Tax Statements: Documenting property taxes paid on real estate owned, which may be deductible on tax returns. Receipts for Charitable Contributions: Used to claim deductions for charitable donations made throughout the year. Health Insurance Forms: Form 1095-A: For individuals who obtained health insurance through the Health Insurance Marketplace. Form 1095-B or 1095-C: Provided by insurers or employers to report health insurance coverage. Educational Documents: Form 1098-T: Reports tuition payments and other educational expenses for claiming education-related tax credits. Less Common Tax Documents: K-1 Forms: Received by partners in partnerships, shareholders in S corporations, and beneficiaries of trusts and estates, reporting income, deductions, and credits from these entities. SSA-1099 Form: Reports Social Security benefits received during the year. Unemployment Compensation Statements: Reporting income received from unemployment benefits, potentially taxable. 1099-C Form: Issued by lenders when canceling debt, potentially taxable as income. Foreign Income Documents: Form 2555: For individuals claiming the Foreign Earned Income Exclusion Form 1116: For claiming the Foreign Tax Credit. HSA or FSA Statements: Detailing contributions and withdrawals from Health Savings Accounts (HSA) or Flexible Spending Accounts (FSA). Rental Income and Expense Records: Including rental income, expenses, and depreciation for reporting rental property income or loss. Gains and Losses Records: Documentation of gains and losses from the sale of assets such as stocks, bonds, or real estate.

Read More »
boulder investment experts
Kevin Taylor

What is Tax Loss Harvesting?

Tax loss harvesting works by taking advantage of the tax code’s treatment of investment gains and losses. Here’s how it works: 1. Identify Investments with Losses: To start, investors review their investment portfolio to identify assets that have decreased in value since they were purchased. These are the investments that are candidates for tax loss harvesting. 2. Sell Loss-Making Investments: Once the loss-making investments are identified, investors sell them. This action triggers a capital loss, which can be used to offset capital gains generated from the sale of other investments. 3. Offset Capital Gains: The capital losses realized from the sale of these assets can be used to offset capital gains from other investments. If the total losses exceed the total gains, they can be used to offset other income, such as salary or interest income. 4. Maintain Portfolio Allocation: After selling the loss-making investments, investors may choose to reinvest the proceeds in similar assets to maintain their desired portfolio allocation and investment strategy. However, there are tax rules, such as the wash-sale rule, that restrict repurchasing the same or substantially identical assets within a specific time frame. 5. Carry Forward Unused Losses: If the total capital losses exceed capital gains and other income, the remaining losses can be carried forward to offset future capital gains and income in subsequent tax years. This can provide tax benefits in the future. By strategically realizing losses and offsetting gains, tax loss harvesting can help investors reduce their current tax liability while maintaining their overall investment strategy.

Read More »

Pin It on Pinterest