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Making the right year-end moves
December 31 is fast approaching. If you haven't yet completed your year-end 529 housekeeping, now is the time to do it.
The following checklist should help. Please realize that this is not intended as a thorough explanation, and you need to understand the legal, tax, and financial ramifications before implementing any of these suggestions.
1. Make the best use of your gift tax annual exclusion
If you haven't already exhausted your $14,000 gift tax annual exclusions, consider making additional contributions to 529 plans or Coverdell education savings accounts for your children or grandchildren before December 31. The annual exclusion recycles on January 1, so if you don't use your 2013 gift allowance by then, you lose it. One of the most attractive aspects of 529 plans is that your contributions help to reduce your taxable estate, yet you do not give up ownership and control of the money.
Remember to include ALL your gifts when figuring out how much of your exclusion you have left for each of your beneficiaries—not just 529/Coverdell contributions, but cash and property gifts made during the year as well. Count even those 529 contributions generated by your participation in loyalty programs offered by Upromise, Fidelity Investments, and others.
2. Make the best use of the five-year election
If you have a lot of money to sock away for college, you will be interested in the election that allows you to make a contribution of at least $14,001 to a 529 plan for your beneficiary this year, and spread it over five years for gift-tax purposes. A married couple not making any other gifts to the beneficiary during the five-year period can conceivably contribute $140,000 to a 529 plan for each child, and with the election, not run into gift-tax problems.
Since it is so close to the end of the year, you may want to limit your 2013 contributions to a maximum $14,000 per beneficiary, and plan on making the big $70,000 contribution in January 2014. This way, you will have $84,000 in gift-tax free contributions working for you in a 529 plan, instead of just $70,000.
Of course, you can always decide to contribute more than what is covered by your annual exclusion (most 529 plans permit contributions of over $300,000 per beneficiary), but then you will be dipping into your $5.25 million lifetime gift exemption. Speak with your tax advisor first.
3. Claim a state income tax deduction
You have an opportunity for immediate tax savings if you live in one of the 35 states (including DC) offering a full or partial deduction for your contributions to a 529 plan. Six of these states—Arizona, Kansas, Maine, Missouri, Montana, and Pennsylvania—allow their residents to use any state's 529 plan while the remainder permit deductions only for contributions to the home-state 529 plan. Be sure you understand the tax rules in your state: Must your 529 contribution be received by December 31? Must you be the account owner in order to claim the deduction? If you have no room to make further contributions for your child under your annual gift exclusion, can you get the deduction for an account you set up for yourself?
Here's a tip for families with children already in college. You may be able to claim a deduction for your contributions to a 529 plan even when you plan to pull the money back out in short order to pay college bills. Check your state's rules for any restrictions.
4. Consider an investment change
All 529 savings programs allow you to request that your account be reallocated among available investment options once every calendar year. If you do so before December 31, you will have all of next year to make another change if you so desire. If you delay and make your first change in January, you will need to wait at least another 11 months before requesting another reallocation. Remember, you can also change investments any time you change the account beneficiary to another qualifying family member.
5. Talk to your tax advisor about losses in your account
You may be able to reduce your 2013 income tax liability by closing any 529 accounts that have lost value. According to the IRS, the loss can be claimed as an itemized miscellaneous deduction for those who itemize their deductions. But you may find little tax benefit in claiming the deduction depending on your personal tax situation. Beware of other potential problems, too. For instance, what happens if you later contribute the proceeds back into a 529 account for the same beneficiary? This may result in a second gift on the same dollars, which could have gift-tax implications.
6. Keep financial aid eligibility in mind
Will your child lose financial aid eligibility because of the way your 529 accounts are positioned? There may be a remedy that is both effective and ethical. For example, if you own a 529 account for the younger sibling of a child about to file the FAFSA federal aid application, that account will have to be included in "parent assets." Some 529 plans will allow you to change to a "custodial" registration, which locks in the future use of that account for the younger sibling and allows you to keep it off the older child's FAFSA. You may also improve financial aid eligibility for a child that has taxable investments in an UGMA or UTMA account by liquidating those investments (but be careful about triggering gains!) and depositing the proceeds into a custodial 529 for that child. Even though the 529 still belongs to the child, the law says that you may report it as a parent asset on the FAFSA. Parent assets are assessed at a maximum 5.64% rate while non-529 student/UGMA/UTMA investments are assessed at a 20% rate.
7. Break out the midnight oil if your child is attending college
Minimize your tax bill by maximizing your use of the available breaks for families incurring college costs. Tax-free 529 plan and Coverdell withdrawals, American Opportunity and Lifetime Learning credits, and tax deductions for tuition and student loan interest payments all depend to a large degree on proper coordination and timing. It's confusing and easy to shortchange yourself. Look to IRS Publication 970 available at www.irs.gov and speak to your tax advisor.
8. Lastly, if you've decided to join a 529 plan but have been procrastinating...
In the words of a famous shoe company, just do it.
Updated November 20, 2013
Joe Hurley is the founder of Savingforcollege.com, and a certified public accountant.