529 plan - The Finance Gourmet

Can I Use My 529 Plan to Pay For K-12 Expenses

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A 529 plan is a tax-advantaged account that allows saving and investing for college expenses. Before last year’s new tax law was passed, one got tax-deferred growth in the account, and tax-free withdrawals for qualified college expenses. Even better, there were very few 529 contribution limits on most plans. Now, the recent tax law has opened up another possible way to use 529 funds tax-free.

529 Plan Withdrawals

Until 2018, you could not use your 529 plan to pay for anything other than higher education expenses, in other words, college. Withdrawals from a 529 plan for any other purpose were not only taxable, but subject to a 10 percent tax penalty. But, the new tax law passed at the end of 2017 changes the rules.

The new tax law allows parents to use up to $10,000 per child for elementary, or secondary education. In other words, you can use up to $10,000 from a 529 plan to pay for private school during the K-12 years. This is a big boon for those who send their kids to private schools.

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Using 529 Money To Pay for Private School

There is a catch.

Of course there is.

You see, when Congress set up the 529 program, they didn’t the Federal government to be the ones who actually implemented it. That would require hiring people, and money, and that isn’t how the Feds usually roll. Whenever possible, Congress likes to dump the responsibility for its brilliant ideas on the states, and that is just what it did here.

All 50 states offer a 529 plan. Those plans are each governed by Federal law in that they must do certain things, and have certain rules and requirements for the money in those 529 programs to qualify for the preferential tax treatment 529 plans receive. Specifically, the funds inside of a 529 plan grow tax-deferred, and if withdrawals from a 529 are used for qualified education, they are tax-free.

Those rules have now been changed so that tax-free withdrawals for K-12 schools, such as private schools, now count as qualifying education.

Remember, however, that the 50 states each set up their own 529 plans, and those 529 plans have rules implemented by the states. While the states cannot change the federal taxation of money in a 529 plan, that isn’t the only consideration. For example, many states offer a state tax deduction for contributions made to the state’s 529 plan. Usually, the states piggy back on the federal rules saying that if you make an unqualified withdrawal, then you have to pay some sort of state tax, and possibly a penalty on that withdrawal.

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The murky part is the exact language of how a 529 plan is setup. For example, if a state copied the former federal rules into the state rules (law), then those rules need manually changed by the state legislature. If the state did not copy the rules, but rather said something like, “qualified deduction under federal tax law,” then those rules were automatically changed along with the federal tax law change.

In the state of Colorado, it seems there is something of a gray area, as this pop-up window shows when you log into the Colorado 529 plan website. The New York 529 plan website has a similar alert.

So, before you run out an pay second semester tuition at your child’s private school from the 529 plan you have saving for college, be sure and research your state law and state 529 plan rules to be sure you aren’t setting yourself up for a state tax hit, or state tax penalty.

States With 529 Plan Issues For K-12 Tuition

This is not an exhaustive list and represents just a quick look. Be sure to check your own state’s 529 plan rules and consult with your financial advisor for specific advice on your situation. Keep in mind that even if the state doesn’t automatically comply with the new 529 plan federal tax law, that doesn’t mean they do not intend to. In some states it is just a matter of having the time to update a rule or pass a law.

These state have either officially said NO to K-12 education spending from their 529 plans, or have said that there is a question or other ambiguity of if it will work. Again, this list is not complete, and other states may have issues now, or later. Also, these states may change their rules at a later date to allow for K-12 tuition payments. Check your own plan’s rules. Currently, these states have official answers ranging from “We don’t know yet,” to “No.”

Colorado
Connecticut
Illinois
Iowa
Nebraska
New York
Ohio
Vermont

These states have affirmed that paying tuition from the state’s 529 plan is OK. This list is also not complete. Check your own plans’ rules and procedures.

Delaware
Missouri
Utah
Texas

2017 Finances and Money Issues

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Welcome to 2017!

Relax. Take a deep breath.

There. Feel better? Good. Then let’s jump in.

Finances Updated in 2017

With a new year, come some new numbers. There will be updates to the maximum 401k contributions, income limits for Roth IRAs, and others. Plus, there will be adjustments to the 2017 income tax brackets, the 2017 standard tax deduction, and more. And, of course, there is a new IRS mileage rate for 2017 as well.

What about 529 plans? There aren’t a lot of updates to those numbers each year, primarily because most facets of 529 college savings plans are administered through the states, who aren’t always as keen on changing and updating everything.

You’ll want to re-evaluate your financial plan for the new year, and you’ll want to review how your financial plan did in 2016. Plus, you’ll want to rebalance your portfolio, if you didn’t do it at the end of 2016.

Retirement Plans 2017

A big part of most retirement plans are tax-advantaged savings accounts like your 401k plan, IRA accounts, and, for some of you, 457 plans, 403(b) plans, and various differed compensation plans. All of those need adjusted and reviewed for 2017 as well.

2017 Income Taxes

A big focus for many people’s finances at the start of 2017 is the looming prospect of income taxes. Start collecting and saving your W2 forms, 1099 forms, and all those other tax forms you get in the mail. However, keep in mind that an increasing number of financial institutions, and even employers are distributing tax forms electronically. Be sure to log into all of your accounts and see if your tax forms are there to download, especially if you have signed up for paperless accounts with anyone.

Set a box, or file folder where you go through your mail so that you can put tax documents in it right away and not lose any. For electronic ones, print and download them so you have them to enter into TurboTax, or give your accountant or tax preparer.

Remember most tax forms are due to be mailed by January 31st.

Also, start thinking about whether you need (or want) to make any retirement plan contributions for 2016 still. You get until April 15th to make the contributions and still count them as a 2016 tax deduction.

Don’t Panic About Money in 2017

Does that sound like a lot?

We haven’t even scratched the surface of making smart money decisions in 2017, but don’t worry. Finance Gourmet will be bigger and better than ever in 2017 to help guide you through with financial recipes for success, and more.

It’s going to be a great 2017.

529 Contribution Limits 2016

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The 529 plan is a tax-advantaged college savings plan. Of course, like all plans that offer IRS sanctioned tax savings, there are rules and regulations regarding just how and when a 529 plan may be used. One of these limitations involves how much money you can contribute to a 529 plan in 2015.

Head over here if you are looking for how a 529 plan works. If you want to know how to open a 529 plan account then head here.

2016 529 Contribution Limits

Unlike IRA plans, where there are new 2016 IRA contribution limits, or other child tax credits, there are no income limits for 529 plans. That means that you can contribute to a 529 plan regardless of whether you are a high-income taxpayer or not.

There are, however, still a few kinds of contribution limitations for 529 savings accounts that you want to be aware of.

The first 529 plan contribution limit comes from the 529 plan rules established by each individual plan. Since 529 plans are administered by each of the 50 states, there can be 50 different plan rules. For each plan, there may be both an annual contribution limit and a lifetime contribution limit. In addition, for states that offer a state income tax deduction for 529 plan contributions, there may be a limitation on how much of each year’s contribution may be deducted.

For example, the State of Colorado has no annual contribution limit, but restricts contributions to a Colorado 529 plan once the account balance hits $350,000. On the other hand, California 529 plans allow contributions until the account balance is $371,000. (Many 529 college savings plan limits are indexed to inflation, or otherwise increase on a regular basis.)

For some taxpayers, the most important 529 plan contribution limitation isn’t actually a 529 plan limit at all. IRS rules state that contributions to a 529 plan are a gift. Therefore, to avoid triggering potential gift tax implications, contributions must be limited to under $14,000 each year, which is the 2016 gift tax limit (unchanged from last year). A married filing joint couple can contribute up to $28,000 per year, which is considered one $14,000 gift from each person.

Special Gift Tax Rule for 529 Plans

There is a special rule for 529 plans regarding gift taxes. Up to five years of gifts can be made in advance to a 529 plan without triggering any estate tax or gift tax implications. In other words, a single person can contribute up to $70,000 in a single year to an individual’s 529 plan. However, such a contribution is considered an advance on future year’s gifts. Therefore, if one contributes the full $70,000 into a 529 plan, then no additional gifts may be made for five years.

Again, a spouse may contribute the full gift amount as well. In this case, a married couple that files jointly could contribute $140,000 in a single year to a 529 plan in 2016 as long as they did not make any additional gifts to that same person for the next five years.

Smart to Use Roth IRA For College

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Should I use my Roth IRA for college?

As a former financial planner, I would often get these questions from clients who read something somewhere. Much like patients asking doctors about drugs they heard about on TV, such questions rarely ended up being a good idea. Still, it is possible to use a Roth IRA to pay for college, but it only makes sense in very specific circumstances.

First, you probably know that a Roth IRA is designed for retirement savings, so that is what it is best used for. The corresponding vehicle for parents saving for college is a 529 college savings plan. In general, the best way to save for college is in a 529 plan versus a Roth IRA. That being said, a Roth IRA can be used, and may be clever in certain circumstances.

Can I Use Roth IRA for College

Let’s start with CAN you use a Roth IRA to pay for college. We’ll look at SHOULD you use a Roth IRA for college next.

As you may know, a Roth IRA offers tax-advantaged growth for investments within the account. This creates two kinds of money inside of a Roth IRA. The first kind of money is contributions. Contributions are the monies directly deposited into the account. They do not include any dividends, interest or gains on investments. If you put $5,000 in a Roth IRA for 10 years, then your contributions are $50,000, no matter what the account is actually worth. Any amount above $50,000 is earnings.

There are two features of a Roth IRA that allow for its use to fund college without paying penalties. First, all contributions can be withdrawn without penalty or taxes. In other words, in the case above, the taxpayer could use $50,000 to pay for college (or anything else for that matter) without taxes or penalties.

The second feature is that there is an exception allowing Roth IRA funds to be used to pay for qualified college expenses. Basically, if you are deliberately trying to stretch what “college expenses” means, it probably counts. Tuition, fees, books, supplies and equipment, at an institution with the word university or community college in the name are pretty much all covered. (Typically, non-degree programs like a coding bootcamp, or writers retreat don’t count.) You are allowed to pay such expenses for yourself, your spouse, your children, and their descendants (that means grandkids and great-grandkids are included).

However, this Roth IRA distribution exception only applies to the penalties that would ordinarily be due. The withdrawal does still count as taxable income. This can be a double whammy, because not only do you owe taxes on these funds, but it also increases your income for purposes of financial aid. Since financial aid takes into account your income, artificially inflating it by taking funds from your Roth IRA may not be a good strategy.

Is It Smart To Use Roth IRA for College?

Additionally, you are literally stealing from your retirement in order to pay for a child’s college. Not only is that money not available for your retirement, but that money is not able to grow while you are still working. At 8% growth over 20 years, that $50,000 withdrawal isn’t just $50,000 gone from your retirement, but $234,500 gone from your retirement.

One of the running themes on this blog is that despite what might be “best” mathematically isn’t necessarily what is right for each of us as unique humans with emotions. For parents who really want to help their kids with college, but who don’t have any other money saved up, a Roth IRA offers a tempting, if non-optimal, way to tap into some funds. That being said, keep it as minimal as possible, ideally, no more than the total amount of your contributions to avoid additional taxes.

Remember, as unappealing as student loans sound, there is no such thing as retirement loans. Consider if you are better off helping your child pay back students loans over time, rather than raiding your retirement savings to send them to college.

If you, or your child, is already looking to pay for school, the Roth IRA is an option, if not the best one. If, however, you are thinking of how, or where to save, consider setting up a 529 plan instead and save money specifically for college.