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The Rules for Withdrawing from a 529 College Savings Plan

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After years of putting money in your 529 college savings plan, you’re ready to start taking withdrawals to pay tuition bills. Do you know the rules for keeping the withdrawals tax-free?

Here’s an overview of three types of 529 plan distributions.

  • Qualified withdrawals. When you take money from the account to pay for college education expenses such as tuition, fees, books, supplies, and equipment, the withdrawals are generally tax- and penalty-free, no matter the age of the account beneficiary.

    Caution: Part of the distribution may be taxable when the account beneficiary receives tax-free assistance such as a scholarship. In addition, you must coordinate 529 withdrawals with the American Opportunity Credit and Lifetime Learning Credit, as well as distributions from Coverdell education savings accounts. These rules prevent the use of the same expenses to obtain multiple tax benefits.

  • Nonqualified withdrawals. The earnings portion of withdrawals that are used for anything other than qualified education expenses are taxable. You’ll also have to pay a 10 percent penalty on the earnings, unless an exception applies.
  • Rollovers. You can deposit or rollover withdrawals into the 529 plan of a family member, or into another account of which you are the beneficiary. When the rollover is completed within 60 days after you take the initial distribution, it’s not taxable.

If you have questions or need help calculating 529 plan withdrawals, please call our office.

Could the Coverdell ESA be the Right Fund for You?

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You’re probably familiar with 529 college savings plans. Named for Section 529 of the Internal Revenue Code, they’re also known as qualified tuition programs, and they offer tax benefits when you save for college expenses.

But are you aware of a lesser-known cousin, established under Section 530 of the code? It’s called a Coverdell Education Savings Account and it’s been available since 1998.

The general idea of Coverdell accounts is similar to 529 plans – to provide tax incentives to encourage you to set money aside for education. However, one big difference between the two is this: Amounts you contribute to a Coverdell can be used to pay for educational costs from kindergarten through college.

Generally, you can establish a Coverdell for a child under the age of 18 – yours or someone else’s. Once the Coverdell is set up, you can make contributions of as much as $2,000 each year. That contribution limit begins to phase out when your income reaches $190,000 for joint filers and $95,000 for single filers.

Anyone, including trusts and corporations, can contribute to the account until the child turns 18. There are no age restrictions when the Coverdell is established for someone with special needs.

While your contribution is not tax-deductible, earnings within the account are tax-free as long as you use them for educational expenses or qualify for an exception. In addition, you can make a tax-free transfer of the account balance to another eligible beneficiary.

Qualified distributions from a Coverdell are tax-free when you use the money to pay for costs such as tuition, room and board, books, and computers.

Please call for information about other rules that apply to Coverdell accounts. We’ll be happy to help you decide whether establishing one makes sense for you.

Considering Paying for Your Child’s College Education?

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Should you pay for your child’s college education? Or should your child find the financing? There are compelling arguments for both sides, but ultimately, your family needs to do what’s best for your financial situation. Most families find that a combination of both works the best.

Parents should pay.

Arguments in favor of shelling out your hard-earned cash for a son’s or daughter’s higher education can be compelling. For one thing, college is a very expensive proposition these days. A year of undergraduate study at a private university can easily top $30,000 and public in-state schools can run over $12,000. Of course, if your student decides to get an advanced degree or go to medical or law school, he or she can run up a bill exceeding the cost of your home mortgage. Advocates of this point of view ask, “Do you really want to saddle your kid with that kind of debt so early in life?”

They add that if your child ends up working to pay for college, that’s less time available for study and making friends. And, of course, friendships built in college can generate a wealth of opportunities for a future career. Also, by investing in tax-deferred 529 plans, parents can withdraw funds free from federal and some state income taxes when it’s time for college.

The child should take the responsibility.

Others argue that covering the cost of your child’s college education should not be your priority. After all, they reason, your kid has a lifetime to pay back student loans, and making loan payments can generate a positive credit history. Advocates of this position also argue that kids who have to pay for their own tuition, books, and living expenses learn responsibility and value the investment that college represents. They also point to available tuition reimbursement plans provided by some companies or the military service option as a way to get a college education without breaking the bank.

Those on this side of the debate often argue that 529 plans are overrated as a savings vehicle because investment options can be limited and tax rules are likely to change, undermining future tax benefits. Finally, they reason that a parent’s own retirement savings should take precedence over saving for a child’s education.

Making the decision.

Of course, your family’s dynamics, the importance you place on a college education, and your personal financial priorities will factor into this decision. If you’d like help looking at the pros and cons of this important issue, give us a call.

Work-Related Education Costs May Be Deductible

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Are you going to school this fall to earn an advanced degree or to brush up on your work skills? If so, you might be able to deduct what you pay for tuition, books, and other supplies.

If you’re self-employed or working for someone else, you may be able to claim a deduction for out-of-pocket educational costs if the training is necessary to maintain your skills or is required by your employer.

Just remember that even when the education meets those two tests, if you’re qualified to work in a new trade or business when you’ve completed the course, your expenses are personal and nondeductible. That’s true even if you do not get a job in the new trade or business.

Work-related education expenses are an itemized deduction when you’re an employee and a business expense when you’re self-employed. You may also be eligible for other tax benefits, such as the lifetime learning credit.

For more information, please contact our office.

Teach Your Children This Vital Skill

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Financial literacy is a vital skill in today’s world. Will your children be able to handle their finances when they became adults? Here are tips to help ensure the answer is yes.

Shave spending. Take the weekly allowance to the next level by helping your child develop a budget. Review the results to reinforce good habits.

Stress savings. Even young children can grasp the power of compound interest. A simple example is asking your child to put a dollar in a piggy bank. Offer to pay five percent interest if the money is still there in a week or a month. Make the same offer at the end of the first time period, and pay “interest on the interest” as well.

Introduce investments. Create a portfolio, either real or paper, consisting of shares of one or more stocks or mutual funds. Make a game of charting the investment’s progress on a regular basis.

Cover credit. Take on the role of lender and let your child request an advance on a weekly allowance. Charge interest.

Talk taxes. Use word search or crossword puzzles to teach tax terminology. Consider creating a “Family Economy” game using examples from your own budget.

Lessons in financial responsibility can benefit your children now and in the future. Get them started on the right path.

Congress renews tax breaks in year-end legislation

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The Protecting Americans from Tax Hikes Act of 2015 was signed into law on December 18, 2015. The law renews a long list of tax breaks known as “extenders” that have been expiring on an annual basis.  This legislation makes some of the rules effective through December 31, 2016. Others are effective through 2019, and some are effective permanently. Provisions in the Act also make changes to existing tax rules that were not part of the extenders. All of these changes will affect your tax planning now and in future years.

Here’s an overview of selected provisions.

  • The provision for tax-free distributions from IRAs to charities is now permanent. When you’re age 70½ and over, this break lets you make a qualified distribution of up to $100,000 from your IRA to a charity. The transfer counts as a required minimum distribution and is excluded from your gross income.
  • If you’re a homeowner, you can exclude mortgage debt cancellation or forgiveness of up to $2 million for 2015 and 2016. Discharges of qualified mortgage debt can also be excluded after January 1, 2017, if you have a binding written agreement in effect before that date. This tax break is only available for your principal residence.
  • If you or a family member is an eligible student, you may be able to claim a tuition and fees above-the-line deduction for qualified higher education expenses for 2015 and 2016. For 2015 tax returns, the maximum deduction is $4,000 when your adjusted gross income (AGI) does not exceed $65,000 ($130,000 for joint filers). The maximum deduction is $2,000 when your AGI is less than $80,000 ($160,000 for joint filers).
  • The deduction for up to $250 of out-of-pocket eligible educator expenses is now permanent. It will be indexed for inflation beginning with 2016 tax returns. You claim this deduction “above the line,” meaning it’s available even if you don’t itemize. If you do itemize, you can also generally claim qualified expenses above $250 as a deduction subject to a 2% of adjusted gross income limit.
  • The optional itemized deduction for state and local sales taxes in lieu of deducting state and local income taxes is now permanent. This deduction is especially beneficial if you live in a state with no income tax. You may also benefit no matter where you live if you pay sales tax on a large ticket item such as an automobile, boat, or RV.
  • When you itemize, you can treat mortgage insurance premiums as deductible home mortgage interest in 2015 and 2016. The deduction is subject to phase-out based on adjusted gross income.
  • You may be able to claim a credit of 10% of the cost of energy-saving improvements installed in your home in 2015 and 2016, subject to a lifetime credit limit of $500.
  • The maximum Section 179 deduction for qualified business property, including off-the-shelf software, is now permanently set at $500,000 (subject to a taxable income limitation). That means you can immediately write off up to $500,000 of the cost of assets you purchased and placed in service during the year. The deduction is phased out above a $2 million threshold. Both thresholds will be indexed for inflation beginning in 2016.
  • You can treat qualified leasehold improvements, qualified retail improvements, and qualified restaurant property as Section 179 property subject to a first-year write-off limit of $250,000 for 2015. Modifications to the definition of certain real property that can be treated as Section 179 property, as well as limitations and the maximum amount available to such property, take effect after 2015. In addition, the thresholds will be indexed for inflation beginning in 2016.
  • The additional first-year depreciation deduction, known as “bonus depreciation,” is generally extended through 2019 when you buy qualified business property. The deduction is subject to a phase-out beginning in 2018 of 10% per calendar year, but you can deduct up to 50% of the cost of qualified property for 2015 through 2017. You can claim this deduction in conjunction with Section 179.
  • The business research and development (R & D) tax credit is made permanent. The law permits eligible small businesses to claim the credit against AMT liability beginning in 2016.
  • The work opportunity tax credit is extended for five years (through 2019) when you hire eligible individuals. The credit is also expanded to include qualified long-term unemployment recipients who begin work after December 31, 2015.

The remaining extenders range from such things as enhanced deductions for donating land for conservation purposes to tax credits for energy-efficient new homes.

The Protecting Americans from Tax Hikes Act of 2015 also makes changes to 529 college savings plans, such as including the purchase of computers and related services in the definition of qualified higher education expenses. The law modifies tax-free ABLE accounts for disabled individuals to allow flexibility in choosing a state program, as well as rollovers of amounts from 529 college savings plans to these accounts. The law also delays for two years the “Cadillac tax” on high cost health care plans.

Because the Act was passed so late in the year, it will be important for you to review your 2015 transactions to take advantage of applicable breaks in order to claim them on your 2015 federal income tax return. Also, with the rules now extended through 2016 (and in some cases beyond), you can begin to update your current tax plan with some measure of certainty.

Contact us for more information and for help determining which changes affect you.

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Congress extends tax breaks in year-end legislation

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In its final session of the year, Congress extended a long list of tax breaks that had expired, retroactive to the beginning of 2014. But the reprieve is only temporary. Read more

Education

Back-to-School Reminder for Parents and Students: Check Out College Tax Credits for 2014 and Years Ahead

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WASHINGTON ― Issue Number:  IR-2014-90 – With another school year now in full swing, the Internal Revenue Service today reminded parents and students that now is a good time to see if they will qualify for either of two college tax credits or any of several other education-related tax benefits when they file their 2014 federal income tax returns. Read more

Education

Back-to-School Tax Credits

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WASHINGTON – IRS SUMMERTIME TAX TIP 2014-23 – Are you, your spouse or a dependent heading off to college? If so, here’s a quick tip from the IRS: some of the costs you pay for higher education can save you money at tax time. Here are several important facts you should know about education tax credits:    Read more

Education

Grandparents Can Help With College Costs

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Are you a grandparent who wants to help pay for a grandchild’s college education? You’ll find several ways to do this, each with its own limitations and tax consequences. Read more