Year-End Financial To-Do: Review 529 Plans and Education Expenses – 2020

By Debbie Placke, Vice President and Manager, Financial Planning Strategies and Marketing

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As 2020 comes to an end, the coronavirus pandemic has proven devastating both in health and finances for many Americans. Countless individuals are looking forward to 2021 with the hope that it will bring with it more peace and stability. Now is the ideal time to review aspects of your finances that are not always front and center. If you have 529 plans in place for children or grandchildren – whether you are in the accumulation or distribution stage – there are some end of year financial to-dos to consider.

Make a contribution to benefit from a state income tax deduction.
If you live in a state offering a state income tax deduction for 529 contributions and have children in high school – or even in college – you can still benefit by taking full advantage of your state’s deduction rules. Even if you pull the money back out in a few weeks or months to pay tuition bills, you have locked in extra state tax savings (check with your state to make sure it hasn’t imposed a waiting period for contributions to qualify for state tax deductions). Although a few states have established an April 15 contribution deadline for purposes of their state tax deduction, most apply a December 31 cut-off. And in some states, contributions must be received by December 31 to qualify, not just postmarked by that date. Couples with future-born children can also take advantage of the benefit in most states by opening the account in their own name as beneficiaries and changing the beneficiary any time after their child is born.

Implement an investment strategy that is in line with your goals.
If the beneficiary of the plan is more than a couple of years away from using the funds, consider how using a strategy such as dollar cost averaging could help you build your plan savings by taking advantage of price fluctuations in the market and balance out the allocation to meet the needs in the future. Ask a financial advisor for information on setting up an Automatic Investment Program. By getting the strategy started now, you can benefit from a state tax deduction for this year and receive a benefit from the gift-tax exclusion.

Another strategy to consider could be the special 5-year election available only for 529 savings plans. This investment strategy allows you to frontload five years of gifts in one year (current annual exclusion is $15,000 for 2020) which means that you can gift $75,000 into a 529 plan ($150,000 if you are married) without any gift tax consequences. Keep in mind, however, that any additional gifts to that same loved one during these years would trigger gift tax consequences.

Take qualified withdrawals to cover any expenses incurred for the year.
If the beneficiary is incurring private school (K-12) or college costs, take advantage of the savings that you have accumulated to cover the costs. Withdrawals of the funds in a 529 plan are income tax-free when used for qualified education expenses which include: K-12 tuition up to $10,000, post-secondary tuition, fees, books, supplies, equipment and some housing expenses for students who are enrolled at least half-time at a qualified organization. Beginning in 2019, qualified expenses also include up to $10,000 in qualifying student loan repayments for the student or sibling of the student. Check with your state to see if loan repayments are considered qualified withdrawals; if not it could cause a recapture of the state tax deduction.

If you have already paid expenses this year, you can reimburse yourself by withdrawing from the plan in the same calendar year. Make sure that you take out the exact amount to match the qualified expenses covered in that calendar year. Although there are no clear-cut rules, a best practice is to pull money from the 529 plan in the same calendar year that the expenses are incurred. You could risk taking an unintentional non-qualified withdrawal if your 529 savings plan distribution is not taken in the same tax year as the qualified education expenses were paid or incurred. In many cases, you have the option of paying the spring semester bill in either December or January.

Any amount distributed from a 529 college savings plan that is not used for qualified education expenses in the same calendar year is a non-qualified withdrawal. This can happen if you take out more than your qualified expenses in a given year, or if you are using the 529 plan for expenses that are not considered qualified. The earnings portion of a non-qualified withdrawal is subject to federal income taxes in addition to a 10% federal tax penalty.

Year-end financial burdens can add stress to the holidays. If you have been saving in a 529 plan, don’t forget about that resource to help lessen the load of education expenses. Make sure you understand how these plans can be used to cover qualified education expenses and make use of the tax advantages that the 529 plan offers. Ask your financial advisor for more information about investing in your child’s future.

Benjamin F. Edwards & Co. does not provide tax advice, therefore it is also important to consult with your tax professional for additional guidance tailored to your specific situation.