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COLLEGE SAVINGS 101

Make up for lost savings in your 529 plan

Christina Couch is a freelance writer living in Chicago.

by Christina Couch

Yesterday she was in diapers; now she's prepping for the SATs. Where did the time go? More importantly, where are the college savings you planned to accumulate by now? For parents who need to make up years of savings fast, here are four last-minute places to find cash for your 529 plan.

Tap into relatives

If an aging relative knows that their time is coming soon, they can give their beneficiaries more by investing in a 529 plan rather than gifting directly.

"Normally, people can only gift up to $13,000 per year ($26,000 for joint filers) before incurring gift tax, but 529 plans have a special rule that allows people to gift five years at a time," says Carl Friedrich, a Certified Financial Planner with Friedrich Wealth Management in Syosset, N.Y. "(Joint filing) relatives who want to leave money can invest up to $130,000 into a 529 plan without paying gift tax."

Friedrich adds that the caveat is especially important to elderly relatives looking to give away their estate by gifting. Instead of handing over $13,000 cash and paying tax on the rest, donors who would like to gift large sums can get more tax-free mileage out of their money by investing it in a 529 plan for their recipient.

Delay the inevitable

"Clients should leave their money in a 529 plan as long as possible," says Mark Atherton, a Certified Financial Planner with Ticknor, Atherton & Associates in Reston, Va. "If they can fund the first years of college using different assets, that gives their money more time to grow."

Families that plan to take out student loans can stash away money in their 529 plan while using the student loan to pay for the initial college years. Then, they can use cash from a 529 plan to pay for the rest. While undergrad Stafford loans have a low 4.5 percent fixed rate this year, parents could find a better deal in home equity, says Dan Goldie, president of Dan Goldie Financial Services, LLC in Menlo Park, Calif. .

"If you're in a state that offers a (state income) tax deduction for your 529 contribution, it might be attractive to borrow from home equity. Put (the money) in the 529, get the tax deduction and let the money grow for a few years," says Goldie. "If the tax savings plus the interest on the 529 investment is greater than the cost of the loan, that could be a sensible investment."

Get shifty

The simplest way to get 529 funds is to pull them from somewhere else.

"The 529 tax advantages are probably going to outweigh the interest gained on a CD or money market account," explains Kevin Worthley, a Certified Financial Planner with the Retirement Planning Co. of New England in Warwick, R.I. "You can also move funds from taxable brokerage accounts."

Families that shift assets from a savings account in their child's name can also improve their financial-aid eligibility. Since the federal government assesses assets in the child's name at a higher rate than parental assets when doling out financial aid, moving money from accounts in Junior's name into a 529 plan will provide federal tax advantages and potentially bigger government grants.

There's a catch. Pulling out of a CD early could cause you to lose some, perhaps all, of the interest accrued on the investment while pulling out of brokerage accounts can rack up hefty tax consequences.

"You can't move stock directly into a 529 plan. You have to sell it first and pay taxes," adds Worthley.

Take a loss

Thomas Donovan, a Certified Public Accountant with Marvin and Co., P.C., in Latham, N.Y., says that families with stocks in the gutter may be able to find college cash by taking a capital loss.

"If a brokerage account has lost money, the account holders can withdraw and declare a loss," says Donovan. "If that loss exceeds their capital gains for that year, they can claim up to a $3,000 tax deduction and reinvest that in a 529."

On top of the capital loss deduction, account holders who go that route could also get a state tax deduction if they reinvest in their home state's 529 plan.

In addition, investors can take a loss on a sunken 529 account, but the rules are dramatically different. To do so, account holders must liquidate their 529 plan, incurring a 10 percent penalty on any interest earned, and they'll have to pay federal and potentially state taxes, according to the U.S. Securities and Exchange Commission. Once the 529 plan is liquidated, account holders can claim the loss as a miscellaneous itemized deduction.

"That's not the same as a capital loss," says Goldie. "529 losses get lumped into the section where you declare employee reimbursements and advisory and tax-prep fees. If those things together are greater than 2 percent of your adjusted gross income, that's the only way you get the deduction."

For a single account holder with a $60,000 income, the loss on a 529 plan plus all other miscellaneous deductions must total $1,200 to claim the deduction. If the 529 lost $2,000, the account holder could claim an $800 deduction, which may not outweigh the penalties incurred by liquidating the account.

"I'd love to tell parents that there's a great way to make up for lost (college savings) time, but there's really not," says Friedrich. "These are incremental things you can do, but there's no magic potion."

Posted September 24, 2010

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