Maximizing Tax Benefits and Savings with 529 Plans
We all know paying for your child’s college education can be stressful. The large tuition bills you’ll have to pay seem daunting, and on top of it you’re paying with all after-tax dollars. Contributing to a 529 plan is a way to ease both of those concerns. 529 plans are tax-advantaged investment accounts designed to help you save for education costs.
529 plans are simple but elegant. When you contribute to a 529 plan, you may get a state income tax deduction for the amount of your contribution. Unfortunately you do not get a federal deduction, but the money grows tax-free, meaning that as long as you use the funds for qualified educational expenses, you never pay tax on the growth. It’s hard to beat that setup!
Before using the funds, you will want to know the rules regarding what constitutes a qualified educational expense in your state. Generally tuition and fees, some room and board expenses, required textbooks, and even some computer and software expenses count as qualified educational expenses. The main area in which states differ is the type of education that can be paid for using 529 plan funds.
For instance, Colorado only allows the funds to be used for post-secondary education. This includes community colleges, private and public universities, undergraduate and graduate programs, and trade schools. While seemingly comprehensive, this list does not cover private school tuition for Colorado residents, which you might pay for before your children attend college or a trade school. These rules differ by state, so it is important to know and understand what is covered where you live.
Now that you’ve heard about the benefits and are curious about opening a 529 account, you may be wondering what type of tax savings you could receive. Say you have Colorado taxable income of $100,000. Your state tax would have been $4,550, but you read this article and decided to contribute $15,000 to your child’s 529 plan. That lowers your state tax bill to $3,868 – about $680 in tax savings. And don’t forget that the $15,000 is money that would have been spent anyways, assuming your child pursues post-secondary education. However, now you get tax savings and tax-free growth on that money.
Strategic Planning for Your Child’s Education with 529 Plans
You can also contribute to more than one 529 plan per year – your children, grandchildren, nieces and nephews could all have plans established that you contribute to. If you are concerned your child won’t attend post-secondary education, there is an option to change the beneficiary on the plan to a different child, grandchild, etc. Just keep in mind that you will have to pay tax and penalties on the funds if you withdraw them and do not use them for qualified education expenses. As long as you are the plan owner, you will control the funds and their use, not your child.
You may be wondering how much to contribute to a 529 plan. This will vary based on the amount you will need for tuition, the age of your child, how large of a state tax deduction you are interested in, etc. There are some important gift tax strategies to consider, as well. The annual exclusion for gifts to an individual is $15,000, meaning that if you gift more than $15,000 to a single individual during a calendar year, you must file a gift tax return reporting the gift. Additionally, the gifts above $15,000 will reduce your lifetime estate tax exclusion, although no tax will be due on the gifts currently as long as you have not used up your entire estate tax exclusion.
Contributions to a 529 plan count towards that $15,000 gift tax return filing threshold. If you want to avoid having to file a gift tax return or using up a part of your estate tax exclusion, you should limit the contributions to $15,000 per recipient per year. However, there is a way to “supercharge” your gift and bunch 5 years’ worth of gifts to a 529 plan in a single year without having it reduce your estate tax exclusion. This is an excellent strategy to use if your child will soon be going off to college, and you want to rapidly increase the value of the 529 plan.
Origin CPA Group works closely with our clients across the world on executing 529 gifting plans. Not only do we help with the current gift and estate planning, but also with distribution planning and long-term legacy planning using 529 plans. 529 plans are a simple yet powerful way that our clients plan for college for generations to come, while staying in control of the use of their funds.
To learn more about this topic contact Origin CPA Group today.