RPF0154-529_Plans_Pt_2
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00:00:15.000 | Today on the show, it's Wednesday, so we work on hardcore, in-depth financial planning.
00:00:21.000 | And today we continue with our master class on 529 plans.
00:00:25.000 | Special focus today on understanding the state income tax deduction system and also a discussion of savings plans.
00:00:35.000 | [Music]
00:00:51.000 | Welcome to the Radical Personal Finance Podcast. My name is Joshua Sheets and today is Wednesday, February 18, 2015.
00:00:59.000 | Today we continue our discussion on 529 plans. Hope you enjoy it.
00:01:05.000 | We're going to try to understand a little bit about the income tax system on the state level and then also try to give you some advice for things to consider if you want to do a savings program for your child's college.
00:01:17.000 | [Music]
00:01:24.000 | I've kind of been putting this show off for a few weeks and even as I sit down – it's a beautiful day here in sunny South Florida – and even as I sit down to record the show today, I kind of feel like pushing this off.
00:01:34.000 | But I think I can do it and I want to get this done. I want to get this information out to you.
00:01:38.000 | And so continuing with this topic, as part of our series, if you haven't listened to episode 138, you will want to listen to that episode first as it sets the overall framework for today's show.
00:01:54.000 | We talk about what are 529 plans, what are the – aka qualified tuition programs, same thing.
00:02:00.000 | Then both the prepaid type of programs and the savings programs, both of those are 529 plans.
00:02:06.000 | Both of them are qualified tuition programs even though you might hear people refer to them differently.
00:02:11.000 | I laid the foundation for where I think they're useful and some of the just benefits of them and benefits and disadvantages of them and how they're very challenging and why I think most people really probably shouldn't be using this account in the way that they are.
00:02:27.000 | One of the things that I emphasized in that show was that a lot of times I think for many people, especially just many normal people who hold these types of accounts, the tax benefits are substantially overstated.
00:02:41.000 | And just as a quick refresher, I'm not saying that people are wrong about how the taxation works.
00:02:48.000 | Just simply that I think that the average experience for the average person participating, that they're really not saving nearly as much money as they think they are.
00:02:56.000 | And so although these can be very useful accounts, it's not the kind of account where I think if you start one for your 10-year-old boy or girl and plan to fund it until the age of 18, it's probably not going to be the – it's not going to result in a massive savings for you.
00:03:11.000 | Now, there is one exception to that and that – the primary exception might be if you are in a situation where you can enjoy a deduction on your state income taxes.
00:03:23.000 | And this is something that we need to spend a little time covering.
00:03:26.000 | Now, since the bulk of my clients have always been – are in Florida where I am, I'm frankly complete novice when it comes to planning for state income taxes.
00:03:36.000 | I realized one time I was working with an out-of-state client. I just realized I'm not so sure that I know what I'm talking about here.
00:03:43.000 | And so if you're working in a state where you have to deal with state income taxes, this is a different type of planning.
00:03:49.000 | So state income taxes can be substantial and because it's state-specific, you'll need to understand your state's code.
00:03:55.000 | You'll need to figure out what are the loopholes in my state's code, where – what are the appropriate deductions and how can I manipulate it to be in my favor.
00:04:04.000 | But the 529 account is definitely an area in which using the account to help you save on state income taxes.
00:04:13.000 | This can be beneficial for you.
00:04:15.000 | Some states do – some states – well, many states actually give the owner of a 529 account either a full or partial state income tax deduction based upon their contributions to that state's 529 plan.
00:04:31.000 | There are a total of 34 states and also the District of Columbia that offer that kind of a deduction.
00:04:39.000 | I'm going to go through each state one by one in just a moment.
00:04:43.000 | The states California, Delaware, Hawaii, Kentucky, Massachusetts, Minnesota, New Jersey, and Tennessee currently have a state income tax program.
00:04:55.000 | But they do not offer a state income tax deduction or a tax credit for contributions to their state's 529 college plan.
00:05:03.000 | So I'll repeat those again.
00:05:04.000 | It's California, Delaware, Hawaii, Kentucky, Massachusetts, Minnesota, New Jersey, and Tennessee.
00:05:10.000 | Again, state income taxes but no deduction for a contribution to a 529 account.
00:05:14.000 | Also then you have the states that do not have state income taxes.
00:05:18.000 | So that would be Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.
00:05:25.000 | These states do not have state income taxes.
00:05:28.000 | So therefore, obviously, there's no deduction.
00:05:31.000 | When you are contributing, if you are in a state where you can take a deduction, for most states, you do need to actually contribute to your own state's plan.
00:05:44.000 | So the way 529 accounts work is they need to be sponsored by a state including the savings program.
00:05:52.000 | So even the savings programs need to be sponsored by a state.
00:05:57.000 | However, in order to get that deduction, then the majority of those states – excuse me, before I get to that – they need to be sponsored by a state.
00:06:04.000 | But you can generally contribute to any state's program.
00:06:07.000 | So for example, in Florida, I could contribute if I wanted to establish an account for my son.
00:06:12.000 | I could contribute to the Florida program.
00:06:14.000 | I could contribute to the California program.
00:06:16.000 | I could choose any state's program.
00:06:18.000 | So when you – it's a little bit challenging when you sit down and try to make your decision of what state's program am I going to contribute to.
00:06:27.000 | It's tough to know because there are so many state's programs and most states have multiple options as far as different fund companies, mutual fund companies that they've partnered with that will allow them to offer that company's fund products in their state.
00:06:44.000 | So it's a little overwhelming.
00:06:45.000 | But usually if you're dealing with your state and if your state has a substantial income tax deduction available to you, you're going to want to contribute to that state's – to your own state's plan.
00:06:56.000 | There are some states that will allow you to deduct your contributions no matter which state's plan you participated in.
00:07:04.000 | And those states are Pennsylvania, Arizona, Maine, Missouri, and Kansas.
00:07:12.000 | So if you live in Pennsylvania, Arizona, Maine, Missouri, or Kansas, you can use any plan from any of the states and you will still be able to take the deduction for your own state's income tax.
00:07:27.000 | The reason that this matters to you is not all plans are created equal just like not all mutual funds are created equal, not all mutual fund companies are created equal.
00:07:36.000 | Not all plans are created equal especially when it comes to fees and expenses.
00:07:40.000 | There are some plans in some states that are extremely low fee and extremely low expenses.
00:07:45.000 | But then there are other plans in other states that are exactly the opposite.
00:07:49.000 | They have substantial fees and very high expenses.
00:07:52.000 | Now, the challenge is how do you make the decision?
00:07:57.000 | And I'll cover that in just a minute after we go through all this because maybe – what fees – let's say that you can save 1 percent on your expenses by using one – a different state's plan other than your own.
00:08:10.000 | What you'll need to do is you need to calculate that and see if it is going to be better for you to have a plan from another state with lower expenses but not take the deduction in your own state or better to use your own state's plan which has higher expenses but be able to get the tax deduction.
00:08:25.000 | So that will be helpful for you.
00:08:29.000 | So – but if you live in Pennsylvania, Arizona, Maine, Missouri, or Kansas, then you can participate in any state's plan.
00:08:36.000 | So that is a useful – for those purposes, those states are useful to live in.
00:08:44.000 | One of the interesting things that emerges with the fact that some states will give you a state income tax deduction is something known as the state income tax loophole.
00:08:55.000 | And in a moment – you know what? Let me go ahead and cover that.
00:08:59.000 | Let me go through this list of states first so that you understand what your state is.
00:09:02.000 | What I'm going to go through is I'm going to go through an alphabetical order, each of the 50 states, and tell you what the benefit is in that state.
00:09:09.000 | I will link to an article on finaid.org – financialaid.org. It's finaid.org that has this chart which is where I'm sourcing my information from.
00:09:20.000 | But I recognize that many of you listen to the podcast while you are commuting, while you're driving, and so it may be inconvenient for you to go and look this up later.
00:09:29.000 | So I'm just going to go through this and share this information with you so you don't have to try to pull out your phone and look through a chart while you're driving.
00:09:35.000 | If this is boring to you, feel free to skip through to the end, just advance 30 seconds, and you'll hear me get to the end of the chart.
00:09:42.000 | So I'm going to go in alphabetical order and just share with you what each state's deduction is that they offer.
00:09:47.000 | So the first state would be Alabama. In Alabama, they allow a deduction of $5,000 per parent and $10,000 joint.
00:09:56.000 | The next state alphabetically is Alaska. Alaska does not have a state income tax, so there is no state income tax deduction.
00:10:04.000 | Arizona will allow a $750 single or head of household discussion – excuse me, deduction or a $1,500 joint deduction for any state plan.
00:10:16.000 | So Arizona is one of those states where they offer tax parity.
00:10:23.000 | So any state's plan, they allow you to deduct $750 for a single or head of household return or $1,500 on a joint return.
00:10:32.000 | Arkansas will allow a deduction of up to $5,000 per parent or $10,000 joint.
00:10:38.000 | California does not permit any state income tax deductions for 529 contributions.
00:10:43.000 | Colorado allows you to deduct the full amount of your contribution. So Colorado allows the full amount of the contribution. That's generous.
00:10:54.000 | Connecticut allows you to deduct $5,000 per parent or $10,000 for a joint return, and they will allow a five-year carry forward on excess contributions.
00:11:07.000 | So if you make contributions more than that number, you can carry them forward and apply them any time over the following five years in which you have the room underneath that limit to deduct them.
00:11:18.000 | Delaware does not permit a deduction for 529 contributions.
00:11:22.000 | Florida does not have a state income tax, so there is no deduction available.
00:11:27.000 | Georgia will allow you to deduct $2,000 per beneficiary of the plan. So Georgia, $2,000 per beneficiary.
00:11:37.000 | Hawaii does not permit deductions for the 529 contributions.
00:11:41.000 | Idaho will allow you to deduct $4,000 for an individual, $8,000 joint.
00:11:48.000 | Idaho, $4,000 individual, $8,000 joint.
00:11:52.000 | Illinois allows a $10,000 deduction for a single individual and $20,000 for a joint return per beneficiary.
00:12:01.000 | And there's a 25% tax credit for employers for matching contributions of up to $500 per employee.
00:12:10.000 | Pause for a moment. Reasons why things like this would be important is you might be able – if you lived in Illinois as an example,
00:12:17.000 | if I knew that Illinois allowed a 25% tax credit for employers for matching contributions of up to $500 per employee and I were self-employed,
00:12:25.000 | then I would be investigating that and investigating using that as a way to hire my son or daughter in my business
00:12:32.000 | and using that credit there to help diminish the cost of my college expenses.
00:12:38.000 | Indiana allows a 20% tax credit on contributions of up to $5,000 with a maximum credit amount of $1,000.
00:12:47.000 | Iowa allows $2,811 of deductions for a single person return or $5,622 for a joint return per account.
00:12:59.000 | Kansas allows $3,000 for a single, $6,000 joint per beneficiary into any state plan.
00:13:06.000 | So again, one of those tax parity states in any state's plan, and that's an above-the-line exclusion from income.
00:13:14.000 | So when I say these words, you should be thinking back to the tax theory that we talked about of above-the-line deductions,
00:13:21.000 | below-the-line deductions. Above-the-line is always more valuable than below-the-line. Credits are better than deductions, et cetera.
00:13:27.000 | So just take that and investigate your state. I'm just trying to go over all of them.
00:13:32.000 | Kentucky does not permit deductions for contributions to a 529.
00:13:37.000 | Louisiana allows a $2,400 deduction for single returns, $4,800 for joint returns per beneficiary, and that's an above-the-line exclusion from income.
00:13:50.000 | And there is an unlimited carry forward of unused deductions into subsequent years. So that's beneficial.
00:13:58.000 | Maine allows a $250 deduction per beneficiary starting in 2007 for any state's plan.
00:14:05.000 | It's an above-the-line exclusion from income, and that's phased out at $100,000 of income for a single return, $200,000 of income for a joint return.
00:14:15.000 | Maryland permits a $2,500 deduction per account per beneficiary with a 10-year carry forward.
00:14:24.000 | Massachusetts does not permit any deductions for 529 contributions.
00:14:30.000 | Michigan has a $5,000 single and $10,000 joint deduction. It's an above-the-line exclusion from income.
00:14:40.000 | Minnesota does not permit any deductions.
00:14:45.000 | Mississippi has a $10,000 for a single, $20,000 joint above-the-line exclusion from income.
00:14:52.000 | Missouri, $8,000 single, $16,000 joint above-the-line exclusion from income.
00:14:58.000 | Montana, $3,000 single, $6,000 joint above-the-line exclusion from income.
00:15:04.000 | Nebraska, $5,000 per tax return, $2,500 of filing separately, above-the-line exclusion from income.
00:15:13.000 | Nevada does not have a state income tax.
00:15:16.000 | New Hampshire, no deductions.
00:15:18.000 | New Jersey, no deductions.
00:15:20.000 | New Mexico allows you to deduct the full amount of the contribution as an above-the-line exclusion from income.
00:15:27.000 | New York, $5,000 limit for single returns, $10,000 for joint with an above-the-line exclusion from income.
00:15:34.000 | North Carolina, $2,500 single, $5,000 joint with an above-the-line exclusion from income.
00:15:42.000 | North Dakota, $5,000 single, $10,000 joint.
00:15:46.000 | Ohio, $2,000 per beneficiary, per contributor or married couple as an above-the-line exclusion from income
00:15:55.000 | and an unlimited carry-forward of excess contributions.
00:15:59.000 | Oklahoma, $10,000 single, $20,000 joint per beneficiary, above-the-line exclusion from income
00:16:07.000 | with a five-year carry-forward of excess contributions.
00:16:10.000 | Oregon has a $2,090 for a single return, $4,180 for a joint return per year, above-the-line exclusion from income
00:16:21.000 | with a four-year carry-forward of excess contributions.
00:16:25.000 | Pennsylvania has $13,000 per contributor, per beneficiary as a deduction into any state's plan.
00:16:33.000 | Rhode Island has a $500 for a single return, $1,000 for a joint return, above-the-line exclusion from income
00:16:41.000 | with an unlimited carry-forward of excess contributions.
00:16:44.000 | South Carolina allows you to deduct the full amount of the contribution as an above-the-line exclusion from income.
00:16:51.000 | South Dakota does not have any state income tax.
00:16:54.000 | Tennessee does not permit deductions against state income tax.
00:16:58.000 | Texas does not have any state income tax.
00:17:01.000 | Utah has a 5% tax credit on contributions of up to $1,740 for a single return, $3,480 for a joint return per beneficiary.
00:17:14.000 | So that's a credit of a total of $87 for a single return or $174 for a joint, when you run the math, on a 5% of that amount.
00:17:26.000 | Vermont has a 10% tax credit on up to $2,500 in contributions per beneficiary, up to $250 of a tax credit per taxpayer per beneficiary.
00:17:38.000 | Virginia has a $4,000 per account per year, but there's no limit age 70 and older, above-the-line exclusion from income
00:17:47.000 | with an unlimited carry-forward of excess contributions.
00:17:52.000 | Washington, D.C., $4,000 for a single return, $8,000 for a joint return as an above-the-line exclusion from income.
00:18:00.000 | Washington does not have any state income tax.
00:18:03.000 | West Virginia allows the full amount of the contribution up to the extent of income as an above-the-line exclusion from income
00:18:11.000 | with a five-year carry-forward of excess contributions.
00:18:15.000 | Wisconsin has a $3,000 per dependent beneficiary, self or grandchild, above-the-line exclusion from income.
00:18:23.000 | And Wyoming does not have any state income tax.
00:18:27.000 | So I know it's a little bit tedious to read through all of those, but hopefully at least you can see how –
00:18:33.000 | although in many states they're similar, there's a dramatic difference even in the states that do allow deductions.
00:18:40.000 | There's a big difference between Pennsylvania's where they'll allow a $13,000 deduction per contributor, per beneficiary,
00:18:48.000 | into any state's 529 plan versus – let's see, Utah, which has an $87 tax credit, up to an $87 tax credit.
00:19:00.000 | Big difference between Colorado, which allows a deduction by the full amount of the contribution, versus Florida,
00:19:06.000 | where there's just simply no state income tax.
00:19:08.000 | And so that – this factor of state income taxes might very well be a large deciding factor for you in your situation
00:19:18.000 | depending on what your individual scenario looks like.
00:19:22.000 | So I hinted at something we call the state income tax loophole.
00:19:27.000 | What's interesting is because you can put these contributions in into this type of account and we can deduct them currently,
00:19:34.000 | you can actually use these for a short-term savings account.
00:19:39.000 | So as an example, if you have a – if you're in a state and you have a child where you have a generous state income tax deduction,
00:19:47.000 | it's possible for you to simply contribute – let's say that your child is 16 years old or 17 years old.
00:19:54.000 | You can contribute to the state's 529 plan in order to take the qualified income tax deduction and then a year later,
00:20:03.000 | you can actually do this as much as maybe a day later and depending on the state.
00:20:07.000 | I mean you could just simply withdraw the funds out and pay the bill for the college.
00:20:11.000 | So as long as the deduction is taken and you have the appropriate amount of qualified higher education expenses,
00:20:19.000 | then you can actually take that state income tax deduction.
00:20:23.000 | Now, most states do – don't have a waiting period on withdrawals, but some states do have a one-year waiting period on withdrawals.
00:20:31.000 | So depending on – you need to check the laws in your state and so you would need to – this would be a useful strategy if you're just simply paying cash for your child's college.
00:20:40.000 | You might want to use this state income tax deduction loophole by funneling the money through the 529 account.
00:20:48.000 | And by the way, if you're in one of those states where your state requires a certain amount of time, so for example, one year between contribution and deduction,
00:20:59.000 | maybe a workaround for that whereas you can simply make a contribution to a 529 account for a different one of your children than for the one who's using the money.
00:21:08.000 | So you can make a contribution to one account with a different beneficiary and then take it out of a different account to do that and set that up and you can research.
00:21:17.000 | That gets too detailed.
00:21:18.000 | But those of you who want to check this out and might want to use that strategy, if you have a state income tax, it might allow you to save some substantial money.
00:21:27.000 | And then also obviously that's going to depend on how much is it worth to you, how much is the hassle worth to you.
00:21:34.000 | If you're in a high-income tax bracket and this can save you – you're at 6 percent. That's a 6 percent discount.
00:21:41.000 | That could be a substantial amount of money where it's worth the hassle to you to go through some of these things.
00:21:47.000 | So while you're investigating 529 accounts, you definitely also want to research your state and see if your state has any incentive programs set up for college savings.
00:21:58.000 | There are just some different kinds. There are – of things available, some programs have like basically seed money like a birthday present where if you open an account for your child before the child's first birthday,
00:22:12.000 | they'll make a contribution of anywhere from $100 to $1,000 into those accounts.
00:22:19.000 | Some programs will match contributions if you have a low or moderate income.
00:22:24.000 | Some programs will actually match contributions to a 529 college plan.
00:22:29.000 | So you'd want to check that out and see if you can find something like that.
00:22:32.000 | There's an interesting program of something called individual development accounts.
00:22:38.000 | You can find information at that at – I'll put a link in the show notes.
00:22:43.000 | It's cfed.org and it talks about the individual development accounts.
00:22:48.000 | But I'll put a link to some articles from FastWeb and from FinAid and they talk about that where they do matching contributions for a certain amount.
00:22:56.000 | So you can – sometimes you can get some substantial benefits in there.
00:22:59.000 | And so if you can use some of these to get some money tucked aside in an account, it might – and increase that.
00:23:06.000 | It might very well be worth it to you to participate in one of these accounts.
00:23:11.000 | Now, let's talk about these accounts and how to actually fund them.
00:23:17.000 | We're going to focus here on the savings types of accounts.
00:23:20.000 | There are primarily two different types of accounts.
00:23:23.000 | There's a direct sold account where you just simply buy this directly from the state.
00:23:28.000 | And then there are broker sold plans where you do this through a financial advisor and through – or through a broker of some kind.
00:23:35.000 | Naturally, there is a difference in fees based upon whether or not you're working with a broker or whether you're working with a direct sold plan.
00:23:43.000 | And benefits to either way, probably there are more benefits in my opinion with just simply going with a direct sold plan.
00:23:50.000 | The major benefit with the broker would be if a broker or an advisor is providing some substantial additional service and this is how they're doing it.
00:23:59.000 | So – and you're compensating for them for that.
00:24:03.000 | So whether that's investment advice, helping you choose investment selection or helping you with other aspects or assets or you're doing some very complicated planning and you're using these as a way of setting up many accounts and to distribute to grandkids, things like that.
00:24:19.000 | And this is all part of the service that your advisor is working with you.
00:24:23.000 | I can see some scenarios where it's going to be better to work with a broker.
00:24:27.000 | That's up to you.
00:24:28.000 | But you can certainly – there are plenty of options where you can simply buy these plans direct and they're directly sold and they're fairly simple if you are good at going through the details.
00:24:38.000 | Now, you do need to wade through that whole state income tax scenario.
00:24:41.000 | Oh, by the way, on the broker thing, it's hard for me to imagine that – it's just hard if you're doing this type of plan which is how many people do it where you're putting $100 a month in.
00:24:52.000 | There's just not going to be that much of an incentive for your broker to give you really great service because there's just not that many dollar figures in there.
00:25:00.000 | There's just not that much compensation.
00:25:02.000 | So you'll probably find this as maybe a service where if you have a bunch of other accounts or you're paying a straight fee, whether that's an hourly fee or some other scenario, then this is where you can find the good service.
00:25:15.000 | But don't expect world-class – just go through and spend hours.
00:25:20.000 | Don't expect an advisor to spend hours and hours and hours working through something where they're going to make about $0.36 on the transaction.
00:25:27.000 | That's pretty much how it is even with the commission-based broker sold products.
00:25:34.000 | But you can go through that and you'll see there's different types of share classes and you can choose what commission structure you want.
00:25:41.000 | Just like any investment selection, just go through and do your research and find out exactly what fits your needs.
00:25:48.000 | On the direct sold plans, probably the best resource that I would point you toward is Clark Howard's resource.
00:25:56.000 | Clark Howard does – he hosts a popular radio show and it's kind of a combination of financial stuff and other stuff.
00:26:05.000 | You'll often hear him talk on a show a little bit about helping with a financial question.
00:26:12.000 | But then you'll hear him talk about helping to save money on a travel ticket and when to buy that ticket to Europe, which is a financial question.
00:26:19.000 | But it's just not straight up financial planning all the time, which I like.
00:26:24.000 | I like his show.
00:26:25.000 | He has a 529 plan guide and from everything I know, I've always heard good things about his stuff.
00:26:32.000 | I've looked at this guide and I don't have any reason to think that I wouldn't – I've sent lots of people to it over the years just because he's done a really good job of researching this stuff.
00:26:40.000 | He puts them and he goes through and he is very focused on fees.
00:26:46.000 | Since that's one of the greatest predictors of investment outcomes is fees and assuming this is the type of account where you can discipline yourself to just simply invest and choose a plan and leave it alone, then by all means, get the lowest price investment.
00:27:03.000 | He recommends unequivocally the Utah Educational Savings Plan Trust, the College Savings Iowa Plan, the New York's College Savings Program that's direct sold, Georgia's Path to College 529 Plan and the Michigan Educational Savings Program.
00:27:19.000 | So those are his plans that is the very best that he recommends where if your state is not listed on his list, then just to go directly with those.
00:27:29.000 | I'll link to it.
00:27:30.000 | You can go through and you can look at each individual state and you can consider it.
00:27:34.000 | Remember, however, you do have to filter this through what state are you coming from and what state are you going to.
00:27:40.000 | Are you in a state where you need to choose your state's plan?
00:27:43.000 | If so, then choose accordingly.
00:27:46.000 | Are you in a state where you need to choose another state's plan?
00:27:49.000 | If so, choose accordingly there.
00:27:51.000 | As far as how to structure the ownership in general, it will be best for the parent of the child to own the plan and then the child just to simply be the beneficiary.
00:28:02.000 | Remember, you can change the beneficiary at any time.
00:28:04.000 | That's easy to do.
00:28:05.000 | But you'll generally want the parent to own it, not the child.
00:28:08.000 | A lot of times there is one – there has been one change of law in the last year or so where if grandparents own a 529 plan, that is counted against the child as an asset for the child's college expenses.
00:28:24.000 | And this is kind of a problem.
00:28:28.000 | The reason it's a problem is because distributions from a 529 plan that a grandparent owns to the student are counted for the purposes of financial aid as cash support.
00:28:41.000 | There are three different types of ways that if somebody is paying a student's college bill, that that payment can be counted.
00:28:51.000 | It can be paid as a – it can be counted as a payment on account in which case that doesn't have any impact on the student aid.
00:29:00.000 | It can be paid as cash support which will actually reduce the aid by up to 50 percent of the amount paid.
00:29:06.000 | Or it can be paid as a – it can be counted as a resource of the student which will reduce the aid by 100 percent of the amount paid.
00:29:15.000 | So if – this can be kind of a tricky scenario if as a grandparent you have accounts set up for all of your grandchildren, then that's considered cash support and that's going to impact any student aid that the child is receiving.
00:29:31.000 | It may or may not be a big deal.
00:29:33.000 | The child might not be receiving any student aid or they might be receiving a lot in which case it can be a huge deal.
00:29:38.000 | So you just want to be careful of that as you're doing it for grandparents.
00:29:42.000 | There are some easy workarounds.
00:29:45.000 | The easiest workaround of that is you just simply want to make the parent – give the money to the parent and let the parent have the money to pay the college bill.
00:29:53.000 | So that way it's the parent's name on the check as the money goes out and that will help.
00:29:58.000 | So that's the easiest workaround and it should be pretty simple to do it.
00:30:02.000 | You could also probably obfuscate it a little bit and just simply make the transfers in such a way that it's not going to show up to the college.
00:30:10.000 | And again, the easiest way there is just have the grandparent give the money to the parent and have the parent make the check out to the college.
00:30:16.000 | That would be the simplest way to avoid that.
00:30:21.000 | The other fairly simple workaround would be simply to make the contributions in the senior year after the aid has been calculated.
00:30:29.000 | So go ahead and make the distributions in the senior year.
00:30:32.000 | If you're trying to fund a $100,000 bill and you only have $25,000 in the last year, then that would be – that would not work very well.
00:30:41.000 | But if you're in the kind of scenario where many middle-income, middle-class people are where it's just $3,000, $4,000, $5,000 here and there, just stack up – stack things up and make all the contributions at the end of the senior year or in the senior year after the financial aid calculations are done.
00:30:57.000 | So that can be a useful little trick for you.
00:31:02.000 | As far as how to actually manage these distributions, when you actually get to the point where if you fund an account and you're taking a distribution from it, it might be helpful to you to know how they actually get reported on the various tax forms.
00:31:15.000 | When you take a distribution from a 529 account, there is no – you're going to receive a form called a 1099-Q.
00:31:23.000 | So the financial institution will send you that form, and it's just simply going to show how much you took out and then it's also going to show how much of that money that came out was – came from your contributions versus earnings and growth on those contributions.
00:31:40.000 | And so then the – so again, it's kind of like annuity taxation where it gets split out on the form and you can calculate it in essence like a ratio.
00:31:50.000 | So if you took a $10,000 contribution – excuse me, a $10,000 distribution and say 7,500 of it was an original contribution and $2,500 of that was growth, then we would – it would be marked on the actual form.
00:32:06.000 | So when you take a qualified distribution, then you actually don't ever report that distribution on your taxes at all.
00:32:13.000 | So for details on what is the qualified distribution, go back to show 138, radicalpersonalfinance.com/138 and listen to all those details on what is a qualified distribution.
00:32:25.000 | But you don't have to actually – you don't ever list the money.
00:32:29.000 | So if you have $10,000 of qualified expenses for your college student or for you and you take a $10,000 distribution, you don't report that distribution anywhere.
00:32:41.000 | There are no forms to fill out. You don't report it anywhere.
00:32:45.000 | Now, certainly you should keep that in your records and you should keep your written evidence of whatever the expenses were in your tax records.
00:32:52.000 | That would be – that would be wise so that if you face an audit, then you can simply say here were the $10,000 of expenses.
00:32:58.000 | Here are the records of that. That would be good. That would be good.
00:33:01.000 | But you don't report it on your income tax return.
00:33:04.000 | If you take a non-qualified distribution, then it's different.
00:33:07.000 | So if you have $10,000 of qualified expenses and $12,000 of distributions, then you have to go ahead and actually report the $2,000.
00:33:18.000 | And what happens is you fill that information in and report the taxable income on your Form 1040.
00:33:25.000 | It's actually line 21.
00:33:27.000 | Line 21 on the 1040 says "Other income list type and amount."
00:33:32.000 | So you would put on there non-qualified distribution, but you would only include the earnings on that page.
00:33:38.000 | You wouldn't include the original contribution.
00:33:40.000 | So in my example, if you – let's just stick with $10,000.
00:33:44.000 | If you had $5,000, you just include the earnings there on that page.
00:33:50.000 | So – no, let's go ahead and do this ratio so you understand.
00:33:54.000 | If you had taken a $10,000 distribution from the account and you had $7,500 of that was a contribution and $2,500 of that was interest, was growth, then –
00:34:09.000 | and if you were reporting $1,000 of non-qualified distributions, what happens is that 25% ratio gets applied to it.
00:34:17.000 | And so you would report 25% of the distribution.
00:34:25.000 | Sorry, I don't think that came out right.
00:34:28.000 | So let me simplify the numbers to make sure that you know.
00:34:31.000 | You have a 75% ratio.
00:34:32.000 | 75% is contributions.
00:34:34.000 | 25% is growth.
00:34:36.000 | And let's say you take $1,000 out as a non-qualified distribution.
00:34:40.000 | Well, in that scenario then, $250 of that would be reported as taxable income.
00:34:45.000 | And so that's how it would go.
00:34:49.000 | You're taxed on the non-qualified distributions based upon the earnings.
00:34:54.000 | Then in addition to the tax, you'll pay a withdrawal penalty.
00:34:57.000 | And so when you take a non-qualified withdrawal, you'll pay a 10% early withdrawal penalty on the taxable portion of the distribution unless there's an exception that applies.
00:35:08.000 | And those exceptions would be if the student were disabled or they went to a military academy or they received a scholarship for cost that would have qualified but because you have the scholarship now, you're not using them.
00:35:21.000 | And then so then you use Form 5329, Part 2, and you calculate that penalty and then that penalty goes on to line 58 of your Form 1040.
00:35:33.000 | So that's how you actually do the calculations.
00:35:38.000 | And line 58 is additional tax on IRAs, other qualified retirement plans, etc.
00:35:43.000 | And you have attached Form 5329 if required.
00:35:46.000 | So that's how the actual tax distribution goes.
00:35:48.000 | So if you're sitting there and you had $10,000 of qualified expenses and you took a distribution and you're saying, "Where do I put this?"
00:35:54.000 | The answer is you don't.
00:35:55.000 | As long as it was all qualified distributions, then you don't.
00:35:58.000 | If you didn't have a qualified distribution, then you need to go ahead and calculate it through.
00:36:03.000 | And man, that got into the weeds.
00:36:06.000 | Forgive me.
00:36:07.000 | If that didn't make sense to you, it was probably because I said it wrong, in which case just ignore what I said and go back through.
00:36:12.000 | That got pretty technical there.
00:36:15.000 | I think that's the bulk of what I wanted to cover as far as the savings programs.
00:36:19.000 | That's the major information I think that will be most helpful to you.
00:36:24.000 | I'm going to go ahead and quit there for today.
00:36:26.000 | I will be coming back with another show on 529s, and we'll talk about the prepaid programs.
00:36:33.000 | There are some things you need to know about the prepaid programs, both from the state-run prepaid programs and also the independent prepaid programs that you can use for private school tuition.
00:36:43.000 | And we'll dig into that a little bit.
00:36:45.000 | We'll dig into the numbers and try to give you some information.
00:36:47.000 | If it whets your appetite a little bit, I can't stand these things for the most part, and I think they're bad use of money.
00:36:53.000 | But they're incredibly popular, and almost every single client I've ever worked with had one.
00:36:58.000 | So hopefully that whets your appetite for that a little bit.
00:37:03.000 | I hope this was a useful resource for you.
00:37:05.000 | I felt like it wasn't one of my best, but I think I'm going to go ahead and ship it.
00:37:10.000 | I tried. I got a little tongue-tied there in the middle, but I did my best.
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00:37:27.000 | And if this has been beneficial to you, I'd be thrilled if you would consider supporting the show as a patron of the show.
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00:38:01.000 | RadicalPersonalFinance.com/patron, and you'll be able to find out all the details on that.
00:38:06.000 | And quick FYI, we will be transitioning the site this weekend.
00:38:11.000 | So this weekend, that would be about February 20th or so.
00:38:15.000 | The website, there might be some outages.
00:38:17.000 | I'm transitioning it over to a new server and setting up a new site, switching hosting companies.
00:38:23.000 | So hopefully, it all goes smoothly and perfectly well. That would be the idea.
00:38:27.000 | But it's also possible there may be some outages.
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00:38:34.000 | But it probably will affect the website.
00:38:36.000 | And so if you come by over the weekend and notice the website is down, now you know why.
00:38:40.000 | That's it. Be back with you tomorrow with an interview show.
00:38:43.000 | Thanks for listening.
00:38:44.000 | [Music]
00:38:50.000 | Thank you for listening to today's show.
00:38:52.000 | If you'd like to contact me personally, my email address is Joshua@RadicalPersonalFinance.com.
00:38:59.000 | You can also connect with the show on Twitter @RadicalPF and at Facebook.com/RadicalPersonalFinance.
00:39:06.000 | This show is intended to provide entertainment, education, and financial enlightenment.
00:39:14.000 | But your situation is unique, and I cannot deliver any actionable advice without knowing anything about you.
00:39:21.000 | Please, develop a team of professional advisors who you find to be caring, competent, and trustworthy.
00:39:30.000 | And consult them, because they are the ones who can understand your specific needs, your specific goals, and provide specific answers to your questions.
00:39:42.000 | I've done my absolute best to be clear and accurate in today's show, but I'm one person, and I make mistakes.
00:39:49.000 | If you spot a mistake in something I've said, please help me by coming to the show page and commenting, so we can all learn together.
00:39:57.000 | Until tomorrow, thanks for being here.
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