COLLEGE SAVINGS 101

Savingforcollege.com

5 year end tax tips for college savers
http://www.savingforcollege.com/articles/5-year-end-tax-tips-for-college-savers-864

Posted: 2015-11-11

by Kathryn Flynn

Updated 2016-11-23

It's hard to believe, but 2016 will soon come to an end. While many of us will spend the next two months enjoying time with family and friends, we also need to remember that once the holidays are over tax season will be just around the corner. Here are some tips for parents and grandparents saving for college that will help maximize any tax benefits they may be eligible for:

1. Determine your total Qualified Higher Education Expenses (QHEE)

Withdrawals from your 529 plan will be tax-free, provided the money was spent on qualifying expenses, as defined by the IRS. This includes tuition, fees, books, supplies, computers and some room and board. QHEE do not include transportation costs, student loan repayments or health insurance. Every 529 plan withdrawal consists of a principal portion and an earnings portion. If you end up taking a non-qualified withdrawal, you'll end up owing income tax and a 10 percent penalty on the earnings portion. However the principal portion will never be taxed or penalized since your contributions were made with after-tax money.

But shopping for the wrong supplies isn't the only way to end up with a taxable 529 plan withdrawal. 529 plan owners can claim the American Opportunity Tax Credit (AOTC) and Lifetime Learning Credit, but you need to make sure you subtract any amount used to generate the credit from your total QHEE. For example, if you qualify for the AOTC you can claim a dollar-for-dollar tax credit on the first $2,000 you spend on tuition and related expenses and a credit for 25 percent of the next $2,000. That means you must subtract $4,000 from your total QHEE that you're planning to withdraw from your 529 plan to avoid “double dipping”. But the good news is that if a non-qualified distribution is caused by this tax-credit adjustment, the 10 percent penalty is waived.

RELATED: Avoid these 529 plan withdrawal traps

2. Take advantage of large, gift-tax free deposits

Contributions to a 529 plan are considered gifts for tax purposes, which means up to $14,000 per year per individual will qualify for the annual gift tax exclusion. But perhaps you're looking to remove a larger amount of funds from your estate. One of the unique advantages of a 529 plan is that it allows you to remove a significant amount from your taxable estate while allowing you to retain control of the funds in the account. What's more, under the special five-year gift tax election, you can deposit up to $70,000 per year per individual. Your contributions will be split into five equal parts, with each part being reported as a gift and applied against the annual gift-tax exclusion over the next five years. Married couples filing jointly can deposit up to $140,000.

RELATED: Are there gift and estate tax benefits for 529 plans?

3. Claim a state tax deduction (if applicable)

In addition to federal tax benefits, over thirty offer a state tax credit or deduction for 529 plan contributions. In order to receive these benefits, most states require you to use your home state's plan. But six states, including Arizona, Kansas, Minnesota, Missouri, Montana and Pennsylvania, are parity states that offer a tax benefit for using any state's 529 plan.

For an extra savings boost, don't forget to reinvest your tax savings ever year. Even a small amount will compound over time and reduce the amount you'll have to borrow for college.

RELATED: How much is your state's 529 tax deduction really worth?

4. Review your investment options

If you've already made one investment change this year – keep reading! In 2014 President Obama signed the ABLE Act into law, which allows 529 plan account owners to make investment changes twice per year. So if you're unhappy with your plan's performance, think you're paying too much in fees, or you recently changed the plan's beneficiary and require a different investment strategy, now is the time to make adjustments.

This is especially important if you're using a static investment option instead of an age-based option. With an age-based option, your plan will automatically shift investments allocations based on the age of the beneficiary. When your child is young, your plan will be more heavily weighted toward stocks, but as they get closer to college the plan will contain more fixed income investments. But if you selected a static option when you opened your account you'll have to make any investment changes manually (and only twice per year).

RELATED: How to select investments in a 529 plan

5. Open a 529 plan (if you haven't already)

If you're saving for a child or grandchild's college education, the end of the year can be a great time to consider a 529 plan. Most states that offer a tax deduction have a contribution deadline of December 31st, but some states, such as Georgia, Oregon and Mississippi, have a deadline of April 15th of the following year. You can also use any money in your 529 plan to pay spring 2017 tuition bills before year end.

You may also be able to claim a 2016 tax deduction even if you don't currently have a 529 plan. In Indiana, for example, anyone who contributes to any 529 plan will qualify for a state tax deduction. So if you have nieces or nephews to buy for this holiday season, why not help them save for college? There aren't too many other gifts that can offer you a tax break!

RELATED: 5 simple steps to enrolling in a 529 plan

Updated 2016-11-23

It's hard to believe, but 2016 will soon come to an end. While many of us will spend the next two months enjoying time with family and friends, we also need to remember that once the holidays are over tax season will be just around the corner. Here are some tips for parents and grandparents saving for college that will help maximize any tax benefits they may be eligible for:

1. Determine your total Qualified Higher Education Expenses (QHEE)

Withdrawals from your 529 plan will be tax-free, provided the money was spent on qualifying expenses, as defined by the IRS. This includes tuition, fees, books, supplies, computers and some room and board. QHEE do not include transportation costs, student loan repayments or health insurance. Every 529 plan withdrawal consists of a principal portion and an earnings portion. If you end up taking a non-qualified withdrawal, you'll end up owing income tax and a 10 percent penalty on the earnings portion. However the principal portion will never be taxed or penalized since your contributions were made with after-tax money.

But shopping for the wrong supplies isn't the only way to end up with a taxable 529 plan withdrawal. 529 plan owners can claim the American Opportunity Tax Credit (AOTC) and Lifetime Learning Credit, but you need to make sure you subtract any amount used to generate the credit from your total QHEE. For example, if you qualify for the AOTC you can claim a dollar-for-dollar tax credit on the first $2,000 you spend on tuition and related expenses and a credit for 25 percent of the next $2,000. That means you must subtract $4,000 from your total QHEE that you're planning to withdraw from your 529 plan to avoid “double dipping”. But the good news is that if a non-qualified distribution is caused by this tax-credit adjustment, the 10 percent penalty is waived.

RELATED: Avoid these 529 plan withdrawal traps

2. Take advantage of large, gift-tax free deposits

Contributions to a 529 plan are considered gifts for tax purposes, which means up to $14,000 per year per individual will qualify for the annual gift tax exclusion. But perhaps you're looking to remove a larger amount of funds from your estate. One of the unique advantages of a 529 plan is that it allows you to remove a significant amount from your taxable estate while allowing you to retain control of the funds in the account. What's more, under the special five-year gift tax election, you can deposit up to $70,000 per year per individual. Your contributions will be split into five equal parts, with each part being reported as a gift and applied against the annual gift-tax exclusion over the next five years. Married couples filing jointly can deposit up to $140,000.

RELATED: Are there gift and estate tax benefits for 529 plans?

3. Claim a state tax deduction (if applicable)

In addition to federal tax benefits, over thirty offer a state tax credit or deduction for 529 plan contributions. In order to receive these benefits, most states require you to use your home state's plan. But six states, including Arizona, Kansas, Minnesota, Missouri, Montana and Pennsylvania, are parity states that offer a tax benefit for using any state's 529 plan.

For an extra savings boost, don't forget to reinvest your tax savings ever year. Even a small amount will compound over time and reduce the amount you'll have to borrow for college.

RELATED: How much is your state's 529 tax deduction really worth?

4. Review your investment options

If you've already made one investment change this year – keep reading! In 2014 President Obama signed the ABLE Act into law, which allows 529 plan account owners to make investment changes twice per year. So if you're unhappy with your plan's performance, think you're paying too much in fees, or you recently changed the plan's beneficiary and require a different investment strategy, now is the time to make adjustments.

This is especially important if you're using a static investment option instead of an age-based option. With an age-based option, your plan will automatically shift investments allocations based on the age of the beneficiary. When your child is young, your plan will be more heavily weighted toward stocks, but as they get closer to college the plan will contain more fixed income investments. But if you selected a static option when you opened your account you'll have to make any investment changes manually (and only twice per year).

RELATED: How to select investments in a 529 plan

5. Open a 529 plan (if you haven't already)

If you're saving for a child or grandchild's college education, the end of the year can be a great time to consider a 529 plan. Most states that offer a tax deduction have a contribution deadline of December 31st, but some states, such as Georgia, Oregon and Mississippi, have a deadline of April 15th of the following year. You can also use any money in your 529 plan to pay spring 2017 tuition bills before year end.

You may also be able to claim a 2016 tax deduction even if you don't currently have a 529 plan. In Indiana, for example, anyone who contributes to any 529 plan will qualify for a state tax deduction. So if you have nieces or nephews to buy for this holiday season, why not help them save for college? There aren't too many other gifts that can offer you a tax break!

RELATED: 5 simple steps to enrolling in a 529 plan

 

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