Monthly top tips

So Says the 529 Guru

No. 21
Joe Hurley
Wednesday, September 28th 2005

Question: My 18 yr old freshman lives at home and commutes 48 miles round-trip three days a week to attend classes. Is the cost of his transportation a qualified expense? If so, how is it computed? Joel R.

Answer: Given the recent hikes in the price of gasoline I can see why you’re asking this question.

At $3 per gallon of gas, and assuming 20 miles to the gallon, your freshman is spending over $20 each week for travel to and from school. And that doesn’t count wear and tear, oil changes, speeding tickets, etc. Even the IRS is sympathetic to what is happening at the pump, and recently raised the standard mileage rate for business use of an auto from 40.5 cents to 48.5 cents for the last five months of 2005. That equates to about $70 per week for your student.

But since the commute to school is not a business expense, the IRS rate is not particularly relevant. Even if it were, you wouldn’t be able to count the transportation costs as part of your student’s qualified higher education expenses (“QHEE”). Section 529 of the tax code defines QHEE as tuition, fees, books, supplies, equipment, and the additional expenses of special-needs beneficiaries required for enrollment or attendance at an eligible educational institution. Room and board expenses can also be counted, but only if the student is attending at least half-time, and only up to the institution’s cost of attendance (“COA”) figure for room and board used in calculating federal financial aid eligibility.

So as you can see, transportation costs have been left off that list, and if you use your 529 plan to pay for school commuting costs on top of all your qualified expenses, you or your beneficiary may have to pay some tax and penalty on a portion of your 529 withdrawals.

I’ve come up with an idea that may give you the desired result. Assuming your child is at least a half-time student, you can direct 529 dollars to him, and he can then reimburse you for his share of the family grocery bill. You’ll be creating additional QHEE meaning you can take more in tax-free withdrawals from your 529 plan. Be sure to check with your child’s school to learn the room and board allowance for students living at home with parents. It’s likely to be less than off-campus students living independently, but should still be in excess of $1,000 per school year.

Then just reimburse yourself up to that amount with tax-free 529 funds. With the extra money in your pocket, you might even decide to let your student borrow your Speed Pass at the gas pump.

Question: In the most recent letter you indicated you have established 529 programs in 33 different states. I can understand doing this for the purpose of having direct information regarding these separate programs for your website/newsletter. However, it got me to thinking. In how many states should folks establish a 529 program? Is there some sort of "mix" that would make sense for this particular program? Larry K.

Answer: Larry, you’re right about my motives in joining so many different 529 plans. It helps me stay on top of developments, and by being the guinea pig I see firsthand how the programs actually operate. Of course, it’s real money my wife and I are putting into these accounts, and we are depending on our 529 investments to help pay for the college bills for our two children. I’m just thankful for the low contribution limits in so many 529 plans that make my research strategy possible.

It’s hard for me to imagine circumstances in which anyone else would want to open accounts in more than two, or at most three, different 529 plans. But here are some reasons that will lead some families to consider using more than one 529 plan:

- Asset allocation. Most 529 savings plans offer investment options that are well diversified among different asset classes (stocks, bonds, money market, etc.). But perhaps your favorite 529 plan lacks some component that you would like to see in your 529 portfolio, such as international equity or small cap value or a principal-protected option. You may find that missing element in another state’s 529 plan and decide to put part of your 529 savings with that second plan.

- Fund manager diversification. Different 529 plans utilize different investment managers. If you are happy with a particular fund company, you may be able to find a 529 plan with investment options investing only with that fund company. But if you want to diversify across different fund companies, you will either need to open accounts in more than one 529 plan, or find a 529 plan that utilizes a “multi-manager” investment platform.

- State tax deduction caps. If the primary reason you are making contributions to your own state’s 529 plan is for the state income tax deduction (offered in 26 states and the District of Columbia), but your intended investment exceeds the maximum deduction allowed in your state, you may decide to go with another state’s 529 plan for the non-deductible portion. That same thinking may apply in states offering a matching contribution or some other limited incentive to invest in the program.

- Combining prepaid with savings. You may want to enroll in your state’s 529 prepaid tuition plan, or in the private-college Independent 529 Plan, as a way of locking in future tuition and fees. Many of the prepaid plans do not cover certain expenses like books, supplies, equipment and room and board. You would have to open another account in a 529 savings plan for these additional expenses.

- Avoiding aggregation. All 529 savings accounts in a state with the same account owner and beneficiary must be aggregated for purposes of the maximum contribution limitation as well as for the calculation of earnings reported on Form 1099 when withdrawals are made. Accounts in different states are not aggregated, even when the account owner and beneficiary are the same. If the maximum contribution limitation in a particular state poses a problem (which is hard to believe considering the high limits in most 529 savings plans), you could open accounts in multiple states to get around it. Avoiding aggregation in the earnings calculation theoretically gives you some additional tax-planning opportunities, but practically speaking is hardly ever worth the extra effort.

The K.I.S.S. principle suggests that you not open multiple 529 accounts unless you have a very specific reason for doing so. And based on the flood of paper I receive in the mail from 529 plans in 33 different states, my advice is to keep it as simple as possible.

» No. 21 - 09/28/05
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