It’s holiday time. Stuff the turkey, shop for gifts, get the fireplace ready-and do your year-end 529 housekeeping.
The following checklist should help. Please realize that this is not intended as a thorough explanation, and you need to understand all possible legal, tax and financial ramifications before implementing any of these suggestions.
Make the Best Use of your Annual Gift Tax Exclusion
If you haven’t already exhausted your $15,000 annual gift tax 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 2020 gift allowance by then, you lose it.
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 plan and Coverdell contributions, but also cash and property gifts made during the year. Count even those 529 contributions generated by your participation in Upromise and other college savings credit card loyalty programs.
Make the Best Use of Superfunding Your 529 Plan
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 $15,001 or more to a 529 plan for your beneficiary this year, and spread it over five years for gift tax purposes. Five-year gift-tax averaging is also known as superfunding.
A married couple not making any other gifts to the beneficiary during the five-year period can conceivably contribute up to $150,000 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 2020 contributions to the one-year maximum $15,000 per beneficiary, and hold off on the big $75,000 contribution until January 2021. This way, you will have $90,000 in gift-tax free contributions working for you in a 529 plan, instead of just $75,000. This trick is known as 6-year gift tax averaging.
Of course, you can always decide to contribute more than what is covered by superfunding (most 529 plans permit aggregate contributions of over $400,000 per beneficiary), but then you will be dipping into your $11.58 million lifetime gift tax exemption. Speak with your tax adviser first.
Claim a State Income Tax Deduction or Tax Credit
You have an opportunity for immediate tax savings if you live in one of the 24 states offering a full or partial deduction for your contributions to the home-state 529 plan. Of course, this presumes you want to invest in your home state’s 529 plan as opposed to an out-of-state program. (The state tax deduction is one of many possible items to consider while shopping for a 529 plan.)
Be sure to understand the tax rules in your state: Must your 529 contribution be received by December 31? Six states allow the state tax breaks for contributions through April 15. 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? Is the state income tax deduction or tax credit limit per taxpayer or per beneficiary?
Here’s a tip for families with children already in college. Investigate whether you can claim the state tax deduction for contributions to your state’s 529 plan even when you plan to pull the money out in a month to pay the next tuition bill. Most of the states allow the state income tax break even if you immediately take a distribution, while four states base the state income tax break on contributions net of distributions. If this is possible, you have made your child’s college education at least partly tax-deductible for state purposes.
Consider an Investment Change
Almost all 529 savings programs allow you to request that your account be reallocated among available investment options twice per calendar year. If you do so before December 31, you will have all of next year to make another change or two if you so desire.
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.
Suppose your child is enrolled in a grandparent-owned 529 plan, which is not reported as an asset on the FAFSA. You can file the FAFSA as early as October 1. If you rollover a year’s worth of 529 plan money into a parent-owned 529 plan after filing the FAFSA, you can also avoid having the distribution count as untaxed income to the student in a subsequent year’s FAFSA.
Be sure to understand the rollover rules, as some states treat a rollover to an out-of-state 529 plan as a non-qualified distribution. In that case, you might have to open a parent-owned 529 plan in the same state as the grandparent-owned 529 plan.
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 tax credits, and tax deductions for tuition and student loan interest payments all depend to a large degree on proper coordination and timing. It’s easy to mess up. For example, qualified distributions from a 529 plan must be made in the same tax year as the qualified expenses are paid.
Lastly, If You’ve Been Procrastinating on Opening A 529 Plan
In the words of a famous shoe company, just do it.
[Editor’s note: This article was originally published on November 19, 2002 and was updated on October 16, 2020 by Mark Kantrowitz.]