Seven items for your year-end 529 checklist

http://www.savingforcollege.com/articles/seven-items-for-your-year-end-529-checklist-684

Financial Professional Content

The fourth quarter of the year is the most important time to review your clients' 529 plans and have them take action when necessary. Here are seven of the most important items to consider.

1. Making an investment change

Review your accounts to ensure your clients are still using the investment options most appropriate to their goals. If not, they should be making their twice-per-year investment change before December 31. You can then suggest up to two investment change anytime during 2018 if circumstances change. If they wait until January 2018 to make a change, only two changes will be permitted until the following January, unless beneficiaries are changed.

2. Grabbing a state tax deduction

Although a few states have established an April 15 contribution deadline for purposes of their state tax deduction, most apply a December 31 cut-off. And in some states, contributions must be received by December 31, not just postmarked by that date.

If your clients live in a state offering a state income tax deduction for 529 contributions and have children in high school—or even in college—they probably should be taking full advantage of their state benefit. Even if they pull the money back out in a few weeks or months to pay tuition bills, they have locked in their extra state tax savings. (Holiday parties are a great time to mention this tactic to college parents. They will be so impressed that they may want to use your services going forward!)

Couples with future-born children can also take advantage of the benefit in most states by opening the account in their own name as beneficiaries, and changing beneficiary anytime after their child is born.

3. Taking qualified withdrawals

Once the 529 account beneficiary begins incurring college costs, the timing of withdrawals becomes critical. The fourth quarter is a great time to take withdrawals in reimbursement of any expenses already paid during the year, or expected to be paid by December 31.

The best approach for many account holders is to simply count up all qualified higher education expenses for the year, subtract $4,000 (but only if planning on claiming the American Opportunity Tax Credit), and request a withdrawal of the resulting amount.

Speaking of the American Opportunity Tax Credit, properly timing the payment of the upcoming spring semester tuition bill—either prepaying in December or waiting until January—can make a difference in maximizing the benefit of the credit. Be sure the 529 withdrawals match up with the payment decision. In other words, your clients should not be taking out 529 money in December for tuition bill payments made in January, or they risk paying tax and penalty on a non-qualified withdrawal.

4. Making use of the gift-tax annual exclusion

The $14,000 gift-tax annual exclusion is "use it or lose it." A 529 plan offers the only opportunity to utilize the gift-tax annual exclusion, reduce future estate taxes, and maintain full control and ownership of the asset (including the right to revoke). Your high net-worth clients should be taking advantage of this opportunity.

The special 5-year election permits frontloading of 529 contributions by spreading as much as $70,000 in contributions ($140,000 for married couples) over five years for gift-tax purposes and applying up to five years' worth of annual exclusions.

For clients intent on starting a 529 account before year-end and using the 5-year election for maximum gift-tax-free contributions, consider the strategy of having them contribute $14,000 by December 31, and another $70,000 in January 2018. This way they will have $84,000 going into the 529 plan rather than just $70,000.

5. Positioning assets and income for best financial-aid eligibility

The critical years for determining financial-aid eligibility begin with the calendar year the student enters his or her junior year of high school: it's the last year that any income reported by the student or the parents on their tax returns does NOT have an impact on aid eligibility.

For example, liquidating mutual funds and recognizing capital gains during the student's sophomore/junior year of high school will have no impact on aid eligibility, but doing so during the student's freshman year of high school could have a major impact.

Notice, when it comes to income it's the "base year" that gets reported on the FAFSA, whereas with assets it's the date of submission value that gets reported. Grandparent-owned 529 accounts can be especially challenging because distributions are included in the student's base-year income, although the account value (being a grandparent asset) is not reportable at all. A timely series of transfers from grandparent-owned 529 accounts to parent-owned 529 accounts can provide the best results, at least on paper.

UPDATE: The U.S. Department of Education announced new income reporting rules for the Free Application for Federal Student Aid (FAFSA), beginning with the 2017-18 school year. Instead of using prior year income as "base year" income, the FAFSA now uses prior-prior year income. For example, the FAFSA will report 2016 calendar year income for the 2018-19 Expected Family Contribution (EFC) determination instead of 2017 calendar year income.

6. Trigger some UGMA/UTMA gains

The kiddie tax kicks in once a child's investment income passes $2,100. It can make a lot of sense to trigger some UGMA/UTMA gains each year, staying below the kiddie-tax threshold, and avoiding the bunching of gains if the client waits until the money is needed for school before liquidating positions. Consider contributing the liquidation proceeds into a 529 account, where future gains will not be taxed if used for college, and where financial-aid treatment of the UGMA/UTMA is greatly improved.

7. Communicate holiday gifting desires

More and more, parents are hoping, and even requesting, that contributions to their children's 529 accounts be substituted for material gifts during Christmas or other gift-giving occasions. For those who feel this way, now is a great time to get the word out to family members and let them know that little Johnny has an account with XYZ 529 Plan. Many 529 plans have a free and easy online "friends and family" gifting service. Alternatively, the family member can simply make out a check to the XYZ 529 Plan and send it to the parent who will then deposit it with the 529 plan. Doesn't this sound a lot easier than shopping at the mall?