Do you have children from K-12 who are enrolled in a private school? Is your child flying this fall to pursue post-secondary studies? If so, you may be eager to tap into the 529 plan you’ve been funding for years. However, before making distributions, consider the following questions.
What is the advantage of a 529 plan?
Contributions to a 529 plan grow tax-free as long as the funds are ultimately distributed to pay the eligible educational expenses of the plan beneficiary. Prior to 2018, this tax incentive was only available if the plan was used to fund the beneficiary’s post-secondary education. Under the Tax Cuts and Jobs Act of 2017, 529 plans can now also be used to cover up to $10,000 of a child’s K-12 tuition.
It is important to note, however, that some states have not updated their laws to include K-12 tuition as eligible 529 plan expenses. To avoid potentially significant negative tax consequences, ensure You should discuss your state laws with your qualified tax professional before using your 529 plan for this purpose.
What post-secondary education expenses can be covered by a 529 plan?
While eligible K-12 education expenses are limited to tuition only, the rules applicable to eligible post-secondary education expenses are more extensive. Eligible post-secondary education expenses include:
n Supplies (including computers and computer supplies); and
n Room and board, limited to the greater of:
1) Room and board allowance included in school tuition for federal financial aid calculation; Where
2) The actual amount charged if the student lives in accommodation managed by the educational institution.
Save your receipts! It may be useful to separate these qualifying purchases from other non-qualifying purchases by performing separate transactions at the cash register.
How might a scholarship or other tax-free tuition assistance affect the use of 529 plan funds?
Tax-free educational assistance, such as a Pell grant, tax-free scholarship, tuition reduction, or tax-free educational assistance program from the employer, reduces the amount payable from a 529 plan. For example, if the cost of one semester of classes is $10,000 and the plan beneficiary receives a tax-free scholarship of $8,000, only the $2,000 remaining $ can be paid using plan 529.
How do 529 plans relate to the US Opportunity Tax Credit and Lifetime Learning Credit?
These tax credits can be extremely valuable. The American Opportunity Tax Credit (AOTC), for example, offers a tax credit of 100% of the first $2,000 of eligible expenses and 25% of the next $2,000 of eligible expenses for a total credit of $2,500. . The Lifetime Learning Credit (LLC) provides a tax credit of 20% of the first $10,000 of qualifying expenses for a total credit of $2,000. However, in order to be eligible for these credits, eligible expenses used to claim the credit cannot be paid using 529 Plan funds. For example, if the beneficiary of a 529 Plan is eligible for AOTC, it may be wise to leave $4,000 of eligible education expenses unpaid by the 529 plan. This will allow the taxpayer to claim the full AOTC of $2,500.
Be aware that the AOTC starts to disappear once your Modified Adjusted Gross Income (MAGI) reaches a certain level. If your MAGI prevents you from claiming AOTC, you can choose to pay eligible education costs in full from your 529 plan.
Do I need to designate the source of funds (eg, 529 Plan funds, scholarships, disbursements, etc.) used to pay for various educational expenses?
If you plan to use a 529 plan to cover qualified post-secondary education expenses and are also anticipating AOTC or LLC eligibility, be careful about expenses that are paid for with 529 plan funds. housing and meals, for example, are not considered a qualified education expense for AOTC or LLC purposes. Therefore, if you plan to leave $4,000 of education expenses unpaid by the 529 plan in order to claim AOTC, make sure the $4,000 of expenses are not for room and board.
There are many important factors to consider before using a 529 plan to pay education costs. The information listed above is not intended to be an exhaustive review of these factors. Before tapping into your 529 plan, consult your Stifel financial advisor and a qualified tax professional to ensure that you are in the right position for the best results.
Investors should carefully consider the investment objectives, risks, and fees and expenses associated with a 529 plan before investing or sending money. The program’s official offering statement, which includes information about municipal fund securities, is available from your financial advisor and should be read carefully before investing. The value of a 529 account can fluctuate and there is no guarantee that an investment portfolio will achieve its stated objective. Your investment may be worth more or less than its original value. Non-qualified withdrawals are taxable as ordinary income to the extent of earnings and may also be subject to a 10% federal penalty tax. State tax treatment may differ. Investors should discuss their particular tax situation with a tax professional.
Article provided by David Hood, Senior Vice President/Investments and Branch Manager at Stifel, Nicolaus and Company, Incorporated, Member SIPC and New York Stock Exchange, who can be reached at the Owosso, Michigan office at (989) 494- 5477 or toll free at (888) 896-8883.