Unwrap the holiday savings at Citadel Outlets. Shop the early access Black Friday sales for the best deals of the season. The all night shopping party starts Thanksgiving night at 8 p.m. Visit CitadelOutlets.com for more information. - Today we continue our series on college planning with part one of the master class on 529 plans.

(upbeat music) (upbeat music) Welcome to the Radical Personal Finance Podcast. My name is Joshua Sheets and today is Wednesday, January 21, 2015. Today we're gonna peel back the curtains on 529 plans, aka qualified tuition programs. Gonna give you all the information that you need to use and exploit this account for your own benefit and also help you to avoid the big mistakes.

(upbeat music) So probably one of the accounts that I get the most questions about and as a financial planner, you have to be familiar with this account. It seems like everybody is using a 529 plan. And so today I'm gonna explain to you a lot and this is gonna be part one of a multi-part show.

I think for this topic, unlike doing what I did with the Coverdell Educational Savings Account Show, which, by the way, you will want to listen to, if you haven't heard it before listening to this show, that show is episode 106. You can find it at RadicalPersonalFinance.com/106 or just search the archives page on the website for Coverdell, C-O-V-E-R-D-E-L-L-S, C-O-V-E-R-D-E-L-L.

So unlike what I did with that where I put everything into one episode, I'm gonna split this out into a multi-part series. And it's partly due to just me recognizing that many in the audience prefer the audio to be in more manageable chunks. So sometimes it is better to take a four-hour show and split it out into maybe three or two or three or four individual shows.

But also due to the fact that there's some natural progression with the 529 accounts and the outline that I have that didn't exist with the Coverdell plans. Now those of you who are daily listeners listening to the show immediately as it comes out, you will notice that I missed yesterday's show.

And the reason is I actually already recorded what you're hearing now, but I wasn't happy with it. And I recorded part one, it was about an hour, of an introduction to the show. And for I think the first time in the show's history, I decided to exercise my license of podcasting as compared to being on the radio to re-record that episode.

I wasn't satisfied with it. It didn't flow quite as well as I thought it should. And so I've rearranged a few things in my outline today to make this show flow a little bit more smoothly and deliver a better resource for you. I'm increasingly aware of the need to make each and every show world class.

I never know where a new listener's gonna come in and stumble into the show. And so I want each exposure to the Radical Personal Finance brand to be positive and excellent. So today we're gonna be actually re-recording part one of the show. Because I missed yesterday's show, today will be extended beyond what was planned for one day's show.

As we begin our content, I want to ask you to stick with me through the content. The information that I'm delivering to you today in this series of shows is master's degree level information. It is not a watered down article that you can read easily at collegesavings.com. This is in depth information.

And 529 accounts are in some ways deceptively simple, but extremely complicated. It's very simple for me to convey the basic points of how they work. I can do that in about 15 seconds and I'm gonna do that in just a moment. But the actual details of how to apply these accounts, it's not so simple.

So one of the things that I would encourage you is stick with me. When I get into complex information, if you don't understand all of the words, if you don't understand all of the terms, just stay with it, even so. I had a mentor years ago who when I first began attending advanced financial planning courses and conferences, encouraged me to go, even if I didn't understand all of the information, and sometimes I just felt like I was swimming in a sea of words that didn't make any sense.

I often go to the estate planning words, what is a defective grantor retained trust? What is a grantor trust versus a non-funded trust? What is a funded account versus a non-funded account? All these different words that if you don't have the background, you don't quite understand. But what my mentor encouraged me, he said, "This year you might understand "20% of the conference.

"Next year you might understand 40%. "But in time, after a few years, "you'll start to understand all the terms." So even if you are a newbie to financial planning or you just stumbled across this show because you're trying to set up an account for your kids and try to figure out what's the best course of action for you, I ask you to stay with it and expand your knowledge.

Over time, the understanding comes. Here's a quick outline of what you can expect as far as how the flow of these shows will go. Today I'm going to give you a brief overview of the 529 plans and explain how they work. I'm also going to outline for you who I think they're a good fit for and who I don't think they're a good fit for with some example financial planning scenarios.

Then I'm gonna go into the history of the 529 plan, even up until current day proposed changes of the law for these accounts. And then I will be going through the major outline of some of the details of these plans based upon the IRS Publication 970's outline. That'll be it for, that's what I anticipate covering in today's show.

On another show, we'll go into the details of prepaid tuition programs, all the things you need to know as you look to choose one of those. On a different show, we will go into the details of how to select among the savings programs and some of the details that you need to know as far as investment selection and some really applied advice for those.

And then possibly in a fourth show, we will wrap up a lot of the details surrounding, we're gonna talk in detail about state income taxes, other ancillary programs that are connected to these in certain states, and some interesting planning uses of them and some interesting ways to exploit these for your own benefit and some things that were probably unintended that you can do with these accounts that I think will be helpful to you.

But let's start with a bit of an overview and explain how these accounts work. So 529 plans, and you'll hear me refer to these accounts primarily as 529 plans. The IRS in the formal literature calls these qualified tuition programs. But the rules for a qualified tuition program are set down in section 529 of the Internal Revenue Code.

So you'll usually hear these referred to as 529 plans. Since that's what's most common, that's what I use myself the most, but I do go back and forth. They're the same thing. Qualified tuition program equals a 529 plan. One misconception, however, that you will often hear and read if you're reading in mainstream financial press is in general, you will be left with the impression that a 529 plan applies only to some sort of savings program where you're setting aside money in a tax-advantaged way for the purpose of college savings.

And you'll hear the prepaid tuition programs, so in my state, Florida, Florida prepaid is very popular, you'll hear the prepaid tuition programs referred to as something other than 529 plans. I think this is what the average consumer understands to be the difference, that you have a prepaid tuition program or you have a 529 plan.

That is factually incorrect. These plans are both authorized and governed by exactly the same section of the Internal Revenue Code. And the rules, for the most part, apply to both ways of organizing them. So both of those types of ideas, the prepaid savings program and the prepaid, excuse me, just the savings program or the prepaid tuition program, both of those are 529 plans, both of them are qualified tuition programs.

So hopefully that will help you to distinguish them as you're reading a little bit in popular literature, but recognize that usually they're gonna be talking about, when you read articles on 529 plans, they're talking about the prepaid savings programs. These plans are massively popular and it's a rare client that I've ever interacted with that was concerned with doing some prudent financial planning who did not have some sort of 529 plan established.

And this is essentially the standard answer for most financial advisors with whom I have spoken or from whom I have learned what they propose to clients. This is basically the standard approach. If you wanna save for college, the financial advisor will most often recommend a 529 plan. 529 plans, they are relatively straightforward.

They're relatively simple. They're easy. There are many options to choose among. The paperwork is fairly simple. So as an advisor, they're very simple for you to help a client set up. Now, whether or not they're the right approach or not, that's a very involved question. My personal opinion is, if I were in charge of giving advice on most financial plans, I would very rarely recommend to most people that they use a 529 plan.

I think that the application, which I see most commonly, which is the idea that we're gonna set aside $150 a month into Johnny's 529 plan, or we're gonna set aside and we're gonna buy two years of tuition credits at our state university for Susie, and we're gonna go ahead and pay that off over the next 18 years.

I believe that the application of that kind of application is, for most people, not a very good idea. And there are a number of reasons for that. One reason is simply that most people are flipping the order that they should be approaching their financial planning. I feel that it's far more important for most people to be focused on their own financial independence and their own retirement funding before they ever focus on college.

There are many, many options and ways to approach college funding. There are many fewer options and ways to approach retirement funding. And yet most parents who establish a 529 account for their child are doing so because of this intense desire to help their children do better. And so they sacrifice their own future to help their children succeed as they perceive it to be.

As they perceive the college degree, having that funded will be helpful for their child's success. Although I applaud the nobility of that motive, I think it's wrong and it's not a good motive. Far better to approach some of the other funding strategies that I've talked about and will continue to talk about.

For example, far better for a parent, in my opinion, to focus on funding their retirement and then just simply stop funding their retirement during the years that their child is in college and contribute to the college education out of cash flow. For example, if somebody is putting money into a 401k and they're contributing, let's say they're maxing the account out at 17, 18,000 bucks a year, then well, let's just stop for four years, putting the $17,000 into that account and use that money to pay for the child's education.

I would rather see that than to see the person putting all kinds of money into the 529 plan. And the reason is because we don't usually know what's gonna happen with college. This is the big blind spot that many people have is they perceive that college and the value of a college education is the same as it was in 1950.

It's simply not. Today, there is no reason whatsoever that any child who wants to go to school and who is reasonably academically capable, enough that they should be going to more academic, through more academic study, you can do it with a part-time job and get a fully accredited degree.

I'm gonna do an entire show on options for this, but you can get them as low as 4,000 bucks now for a full tuition cost for an accredited degree. There are proposals, which I'll comment on in just a moment, but President Obama even now is proposing to make the community college tuition to be completely free.

In fact, let's go right there. That's the second thing, is the value, as perceived by the marketplace, the value that is being placed on a college tuition, I believe, is changing. Now, this is one where I can't prove it with statistics 'cause the statistics are backward-looking, but if you just open your eyes a little bit and look around in the press and just read about what you're reading about, and you see major companies, the leaders, walking away from the value of the college degree in their hiring practices, that should tell you something.

I think you can get a good indication even of the value of a college degree as indicated by President Obama's proposal. When you make something free, it's because the value is either pretty low or it's gonna drive the value low. And community colleges have already been essentially free, so that value there is low, and as they are made free with a show of populist support, trying to gain support, well, we're gonna support low-income families to do that.

I think that's probably a pretty good indication that the value of college is pretty much gone because as it stands right now, education is free and has been for a very long period now in human history. You can trot right down to the library and you can learn just about anything you need to learn.

You can open up your phone, access a computer connection, an internet connection. If you don't have one, go to the library and use the free internet connection that's sitting there, and you can get all the education that you need. Now, the credentials are not free, but there are plenty of cheap ways to get those credentials, and the value of those credentials seems to be really dropping in the marketplace.

That's my opinion. I can't prove it to you at the moment, but that's just simply my personal observation. I could be wrong. Again, most of the research indicates that investing in education still pays off in earning power, but I've not seen, anyway, you get into causation, correlation, that type of thing, which causes me to question that, and I'm not the only one.

One of my major points with parents is just simply, how do you predict where things are gonna be in 15 years with the current rapid pace of change in our society? And change has always been rapid, but it certainly seems to be changing substantially. If you go back, if you have a young child, and you go back 15 years and think about what the world looked like in 2000, and compare that to what the difference between 1985 and 2000, there was a lot of change, and go back another 15 years, go from 1985 back to 1970, just compare the rate of change, the world of 2030 is going to be dramatically different, and one of those massive changes is going to be the structure of the schooling system.

Now, just because Joshua has that opinion, which regular listeners know certainly is, certainly an opinion that I have, doesn't mean that you can't use this kind of account for your benefit, but I do like to point out and explain the limited benefit of this account for most people who are contributing.

How it's not, it's just simply, it's not a panacea, it's not a magic cure-all. So let's get into how it works, and so ignore for a moment, well, the tuition credit programs, those are fairly simple, and basically you contract with either your state school system or an independent consortium of private colleges, which we'll go over, I'll tell you how to use the tuition credit to fund private universities, so if you came from a prestigious Ivy League school that's a private university of some kind, and you're sure that your son or daughter is going to attend that school, you can just go ahead and purchase those tuition credits today, and I'll explain that in a future show.

But the tuition credits are fairly simple, you just pay the price that is negotiated by the state that is offering you the program. On the savings programs, the accounts in today's world function in some way similar to a Roth IRA. You fund the accounts with after-tax dollars, so you do not get any up-front deduction for putting money into this account.

As the money stays in the account and grows, hopefully, with the performance of your investments, then that growth is tax-deferred, and when you take the money out and use it to pay for qualified education expenses, those funds come out tax-free, could be used to pay for that. Now, anytime you get into a tax benefit, or anytime you get into one of these accounts, you need to actually calculate for yourself what is the potential tax benefit.

Very few people ever actually calculate what the potential tax benefits would be. And so let me use, in my own personal planning scenario, I have a one-year-old son, let me use him as an example of what we could or could not do. Let's assume for the moment that he's one year old, and we're gonna be saving for his college, and we're assuming he's gonna go to college at the standard age of 18.

So that gives us a 17-year investment time horizon. Let's assume that we have calculated our budget, and we found that we can afford to allocate $100 a month for the savings toward his college tuition. I can get in, I've gotten into in previous shows about how to actually calculate the amount needed for college.

If you're interested in that, go back and listen to those shows. Specifically, that would be episode 101, which was entitled "How to Calculate "How Much You Need to Save for Your Kid's College." But for this illustration, we're not trying to hit its targeted amount, we've just decided we can save $100 a month.

And this is a fairly normal approach among many people with whom I have worked. And let's assume that we're just going to put the money into an investment account, and let's assume that we're going to earn a nominal return after fees of 7%. So in our investment account that we're funding this account with.

So we just pull out our little financial calculator, and you clear the registry, you hit 17, hit your little button to switch it to monthly, 'cause we're gonna make monthly contributions. So that comes out to be 204 periods, 204 months is how much we're gonna be investing for. Put 7% in, turn that into a monthly number, that's .58% interest compounded monthly, starting with $0 and $100 as our payment.

And hit your future value button, and that'll tell you what the future value of this account would be. The future value in this scenario is $39,240. So if we calculate how much we've contributed to the account, we've invested for 204 months, so 204 times 100 equals $20,400. So our total contributions to the account are $20,400, and we have $39,240 in the account.

For the sake of straightforward, easily understood verbal numbers, let me assume that's $40,000, and we've contributed $20,000 to the account. So we essentially have $20,000 of capital gain in this account. What that means is that now I can use that money, and I can use it to pay for college expenses, and I will not have to pay the income tax on that $20,000 of gain.

Well, how much is that income tax rate? I think it would be comparable to say, this would probably, if I weren't using a qualified college account for this type of investing, let's just assume I can do it at capital gains tax rates of say 20%. Current highest capital gains tax rate, 20%, ignoring the 3.8% Obamacare taxes.

Let's just say 20%. So what would be the actual tax savings at a 20% rate on $20,000? The answer is $4,000. So by using this 529 account, this illustration, me saving for my one-year-old son, I would be able to save a total of $4,000 of tax. Is that substantial?

Maybe, depending on your specific scenario. Tax planning, good tax planning is never one thing. People often ask, Joshua, what's the one thing you can do? There is no one thing. There are a lot of little things. And if you do enough little things over time, that accounts to be a massive amount of savings.

For $4,000, it doesn't get me that excited, especially when I look and say, well, are there some ways to dramatically affect the overall cost of college that will have a much greater impact than $4,000? Could I get an extra $4,000 of financial aid for my student by not having the money saved?

Seems to me that would be a pretty easy thing to do. So instead of having the money saved and having it counted, why don't I just take advantage of the financial aid programs? Couldn't I get some scholarship money to make up that difference and wouldn't that make a bigger difference?

All of those things can be done. Just because you have money saved doesn't mean you can't get financial aid. Just because you get financial aid or have money saved doesn't mean you can't qualify for scholarships. My point is that $4,000, you have to look at it in terms of your scale and ask, is that a good assumption or not?

Now, one challenge is that I use that 7% net of fees number for our investment return. What if it were higher? So what if instead of 7%, you could actually get 10%? Well, under this scenario, if you could get a 10% return, you would have $53,000 in the account at the time for college, which taking out the $20,000 of contributions would leave you with about $33,000 of gain.

So now that would improve things. But here's the question. If you're actually investing for a medium-term goal, like college, which has a defined price tag, are you going to be comfortable with high volatility in that account? And how are you going to account for it as you get closer?

My observation has been that it's a little harder to make this work. So unlike in retirement planning, where I can say to a retiree, listen, you're gonna be retired for a very long period of time. So even if you are in this year retiring, you still have a 30-year investment time horizon, and thus I can make a case for broader exposure to potentially higher returning asset classes, i.e.

equities instead of bonds. It's hard for me to make that case here to somebody with college, because starting at the age of 14, excuse me, 13, we're five years out from the age of 18 when we're gonna need college money. And even at our five-year time horizon, which is often where mentally you start to think about how do I shift a portfolio from potentially volatile investment assets over to a less volatile approach, you can start to think about it at the five-year time horizon, that still happens at the child's age 17, 'cause the most cash, like our cash flow needs are pretty much done at 22, unless the child needs to go to graduate school.

So managing the portfolio for this purpose is a little bit tougher. Compare even that to my solution, such as one of my preferred solutions, such as funding a retirement account. If we're funding a retirement account, and let's say that we're planning to use the exception to tax penalties under the education exception to early distributions from an IRA, let's say we're gonna use that as a funding plan, or we're gonna use, hey, I'm contributing to my 401(k) and I'm just gonna stop or lower my contributions for these years while my child is in college to make up for the amounts that I'm putting in there.

If you compare these two plans, at least in the retirement account, if the volatility is, we're in a period where the market is down and our investments are low in value, well, you've still got a long time horizon 'cause you just use the money later for college, excuse me, for retirement, and you can find, you can cash flow the need.

Unlike in a 529 account, where if it's all designated for college, it's a little bit trickier to get the benefit of the money out. So because of this challenge of how do we do the, how do we actually calculate this stuff out, I think that 10% is certainly much higher number than I would ever use as a projection for a return on investments in a college account when we're managing a portfolio for this fixed period of time.

7% is probably a little bit aggressive, and I would guess that of many of the allocation plans that I have reviewed, maybe somewhere on the order of 4% or 5% would be much more appropriate as far as an expected return from a portfolio. Well, if we put 5% in instead of 7%, then our future value after 17 years of investing, oops, I did this wrong, 17, 5%, zero PV, $100 a month.

Our future value after 17 years of investing now is $32,186. Pull out our $20,000 of contributions, and we have $12,000 of gain at a 20% tax rate. That means we're avoiding $2,437 of taxes. And I think this is what many people who are participating in 529 plans are facing.

Now, again, this is anecdotal from my observations, but I think it's pretty accurate. I feel pretty good about this guess. I just don't really see the point. When there are so many other things that can be done, take my plan, one of my plans, skip college, stop wasting money on expensive private schools and expensive tutors, and stop wasting money for an expensive public school district.

Pull your child out, put him in education at home, and plan to have, with a combination of CLEP tests, AP exams, and dual enrolled credit at a community college, which will be free soon enough, and is practically free now, have the four-year degree done by the age of 18, and forget about the college account.

Now, that's what I think makes a lot more sense for an average mainstream person. Is any of this analysis necessarily a problem of a 529 plan? No, and I'm gonna show you how a 529 plan could be incredibly useful. The point is not whether one account is better or what you should do.

The point is to use that lens of scale that I've recently talked about, and think about how you could establish something that works for you. As a financial planner, there is a big difference in my need to plan. If I'm working with one client who says, "You know what, I've got an engineering degree "from a university that's near me, "Florida Atlantic University.

"It's a perfectly good university. "It's a state of Florida school. "It's in Boca Raton, Florida, "which is relatively near where I live. "I've got a degree from there. "I think I had a great experience there, "and I wanna make sure that we just have "a little bit of money to pay for that, "and help our child to go there." That's a very different scenario, and get their undergraduate degree.

That's very different than if a client comes to me and says, "I'm a graduate of a prestigious big-name school, "Harvard, Yale, Brown, Cornell, "some school with 150, $200,000 price tag. "And more importantly, I'm a big believer "in advanced education. "After all, I'm a doctor, I'm an attorney. "I'm a PhD in some arcane field, "and I wanna make sure that I have enough money "to send my child through medical school, "or through graduate school of some kind "at an expensive university, "so that they can build their social structure, "and make sure that they're involved "in the who's who of the decision makers of our country." That's a very different scenario.

And so now, the advantages and disadvantages, what to do in one case versus what to do in another is gonna be very different. So those are the limitations that I see at the 529 account. Now let's talk about what are some ways that you could use the account, and how it could be much more useful.

Well, one of the first things you could do is if you could increase the investment return. That could be useful. It's a little tough to do, though, because 529 accounts are relatively restricted on what they are invested in. They're either invested at whatever the state says, at a guaranteed return based upon the tuition credits that you buy, and you can calculate that, or they're invested with relatively mainstream mutual funds.

And you're going to be subject to whatever the mainstream mutual fund returns are. It's not a problem. Might be perfectly great, or it might not be. You would have gotten hammered if you bought a mainstream mutual fund in 2000 for your 10-year-old, your eight-year-old child, and then in 2010, needed to get the money out for college.

That probably wouldn't have worked in most of those scenarios. So it's tough to influence rate of return, and unlike the Coverdell program where I talked about you could do some more aggressive types of investing, can't do that here. But you could extend the time horizon. And the other major key for 529 plans is you could front load it.

Here would be the example. Let me use my $100 a month example, and we calculated that total I would be investing into that account $20,400 over 17 years to fund my one-year-old son's education. Let's say that instead of funding this at $100 a month, I choose today to write a check for $20,400 into the account.

What would be the value of the account at that same 7% interest in 17 years? Well, let's just plug it in our calculator. $20,400, change the sign, put it in as our present value. 17 years. Let's compound this monthly to make sure that's the same. So that's 204 periods, 7%, that's 0.58% per month, and zero payments into the account.

Well, now my future value in this account is $66,825. All I've done here is change, and instead of putting $100 a month of periodic payments into the account, I front loaded it. So the full amount can be earning interest along the way. $66,825 compares to our previous number of $39,240.

It's a big difference. That's an extra $27,585 of tax-free gain in the account simply because I front loaded it. And this is a huge advantage of the 529 plans. You can make contributions to these accounts up to the annual gift tax exclusion amounts. So in 2014 and in 2015, this number is $14,000 per person.

The annual gift tax exclusion amount is the amount of money that any individual can give to another individual without paying gift tax on the amount. So anybody can give $14,000 to any other person for $14,000, and there's no tax on that transfer. There's no gift tax on the transfer.

Whether or not there's income tax on the transfer will depend upon the assets that are actually transferred. It's a conversation for another day, whether they're appreciated assets or whether they're just cash assets or whatever they are. But just for now, assume that there's no tax on the transfer. The other nice thing is that you can do what is called split gifting, which means that if you're married, you and your spouse can both choose to make a gift contribution to any other person.

So now you can give $28,000, and that's a fairly straightforward thing to do. In a 529 account, you can contribute up to five years of that amount into the account, and for technical purposes, it will be considered to have been given over five years, even though you gave it all in the first year, which means that let's assume now that my wife and I are somewhat wealthy and we're looking for intelligent things to do, and education and college and higher education is a big deal to us, and we want to set aside money for our grandchildren.

Now, we don't have any grandchildren yet, but here's what's cool. That doesn't matter. We can make the beneficiary of the account ourselves, we can make the beneficiary of the account our children, and then we can just transition this to be our grandchildren. And we can put, for each individual beneficiary, we could put 28,000 times five, so $140,000 into that account right now.

So, play a little game with me. Assume that I establish an account right now for my son, and I front load that with $140,000 of capital into the account. So I put in $140,000, that's the present value, let's put in 17 years for the number of years, let's do this monthly, let's put in our 7% interest compounded monthly, no future contributions.

Now, with that amount put in, I've got $458,000 established to fund my child's college. And all of that gain would be tax free. All of it, if used for higher education expenses. But this would be really cool. Let's say that instead of using that, although I could use that for my son's college, and I could calculate pooling out $200,000 and then the balance staying in the account for a grandchild, it's a little hard to do, a little cumbersome over audio.

But let's just assume that instead of doing this for 17 years, I do this for 17 years plus 25. Assume that my son gets married and has a child at 25 years old, so that gives me 42 years of investment time horizon. And I fund this account, $140,000 today, 42 years compounded monthly, 7% compounded monthly, zero dollars into the account.

After 42 years, this account would have $2,625,000. 694. $2,625,694.27. That's pretty exciting when you consider the fact that I put in only $140,000 of capital up front. So my total gain in the account is $2,485,000, which if used for college education, is completely income tax free. That's pretty exciting.

And what's cool about this is I don't have to go through the hassle of setting up an elaborate trust. I don't have to actually make a completed gift to the child. I can have full control over this money, I can change beneficiaries, so unlike setting up some sort of transfer with a custodial account such as a UTMA or a UGMA account, where that money, no matter what, is going to be transferred to the child at their age of majority, I can pull this money back.

I can use it. In fact, if I don't like any of them, I can change it to be for me. And my wife and I, we might go and sign up for a four year university in Paris, and we might go and get French degrees in Paris and pay for it all out of this account, and consider that for four years of our retirement plans, and just pay for it with this account.

So there are a lot of options, and that's where these 529 accounts really tend to shine. Again, nothing wrong with the account. The problem is how they're applied usually. I hope that's kind of a unique introduction to understand what you can do. And 529, since they were invented, have been a very useful tool for financial advisors.

Very useful tool. They're unique. Now, where I'd like to go from here, one comment before we get into the history of the plan. It's unlikely, this is, 529, it's unlikely that you're gonna, this is another one of those examples of where it's tough to get great financial advice on it.

If you wanna go out and ask a financial advisor just to handle your 529 account, good luck finding one. I personally would never have accepted this from a client, simply because there's not enough money to make any compensation where it's worth the responsibility that I would hold towards a client.

So when I was practicing officially, then we would do 529 accounts, but as a service for clients who had other assets, or other services, or other planning needs, or other products with it. So if you listen to this show, or this series of shows, you'll probably have more knowledge about this than many financial advisors.

So just recognize that, you're probably, this is one of those where you gotta do it yourself, and you gotta think through it yourself. It's not good business practice for a financial advisor to spend several hours going through these things when there's a total potential compensation of, if you're gonna do it $100 a month, might make $3 a month of compensation.

You can't run a business that way. So hopefully that helps. Just listen, focus on this show, and then you'll figure out what you wanna do. If you have an advisor with whom you have other services, other products, other planning relationships, then go ahead and lean on that person for information here.

But it's just tough to, it's tough to find a good advisor who's gonna work with you on this information. That's just the reality of the situation. Now, let's get into the history a little bit. And this history is important. I'm gonna take some time to go through this. Because it will give you some insight into how these types of things come to be.

And you might be able to apply that insight to other areas of your financial planning. One question which I'm often asked is, "Joshua, are you concerned about the rules changing "on things like retirement accounts?" The fiscal situation that we face in the United States is that we're broke, practically bankrupt, but we won't admit it.

And so our economic system just continues forward. And you have what purports to be a debate between the Democrat Party and the Republican Party, where in essence, the Democrat Party is supposedly known for we wanna raise taxes on the rich, and that's gonna fund the problems, that's gonna fund the government.

And the Republican Party is supposedly known as we're gonna cut taxes on the rich and on everybody else, and that's gonna fund the economic situation. That's gonna fund the shortfalls. The reality is, is that although each party says that they're different, they both do exactly the same thing when push comes to shove and when during times of economic recession, economic hardship, then regardless, and you'll see this proven in this history that I'm gonna go over with you, you see that taxes are cut.

And it happens under Democrat presidents and Democrat Congresses, or Democratic Congress, and it happens under Republican presidents or Republican Congress. And so you practically have two parties that are, in essence, exactly the same and do exactly the same thing, but their rhetoric has to satisfy a different interest group So one of the challenges of thinking through things like IRAs is when I look at the reality of the fiscal situation of this country, depending on which estimate you use, you'll get different estimates of how massive the problem is.

Some estimates you read are that the US government has approximately $150 trillion in debt and unfunded liabilities, which includes the amount that the government is behind, the amount that's not funded to pay for the three big social programs, Medicare, Medicaid, and Social Security. Some estimates go as high as about $220 trillion.

My source for that is Professor Lawrence Kotlikoff from Boston University. I've never found any reason to dispute his numbers, so I usually would just quote a $220 trillion problem. And so you look and say, how can that be solved? And I don't personally see any viable solution to how that's gonna be solved in the long run.

But in the short run, who knows how long it can go on? That's the question. And the other question is, well, what changes are there? Well, tax-advantaged programs are referred to by tax wonks as expenditures, tax expenditures. So there's a listing, and these are constantly debated in Congress and in committees about, well, where are we gonna get the money from?

And how are we gonna get the taxes to be raised? Tax expenditures, based upon my memory, I think they were popularized by, I forget the name, but the guy who was the Treasury Secretary in the late '60s. And he came up with the idea of, instead of funding something directly from the government coffers, why don't we just simply offer a tax incentive and a tax bonus, and that will incentivize people to take a certain course of action, which we have decided is in line with our national values.

And so this is what you see. This has become, it's theoretically, and probably a much more efficient system. As an example, why do we, well, it's a much more efficient system. But it's also a system that in some ways is easier to account for or is easier not to account for.

So you constantly see that the tax code is built to incentivize certain courses of action. So the powers that be have decided that it's in the best interest of this nation that people are homeowners. So therefore, the tax code incentivizes home ownership by giving a deduction for real estate mortgage interest on a primary residence.

It gives a deduction for real estate property taxes. We've decided that it's in the best interest for employers to fund and provide health insurance for their employees. So it gives a deduction, a full deduction, for the costs and the contributions of employers to the health insurance payments. We've also decided that it's in the best interest of this nation that people save to fund a retirement.

And so that's why tax schemes such as IRAs, 401(k) plans, pension plans, why these have the tax rules they have, Roth IRAs, et cetera. Now, it's tough for me to think through and figure out what would actually happen or could the rules change. I have a few disadvantages for my thinking.

Number one is because of my relatively young age, I haven't been paying attention to how politics actually functions for really all that long. I probably started paying attention in my mid teens and now at almost 30, that only gives me a decade and a half of observation. In that decade and a half, I figured out that although the politicians say they do some things differently they don't actually do anything differently when it actually comes down to it.

But when I look at the political reality, I do see that the, I guess the voting power of the populace I think still has power. And when you look at things like tax changes, Congress still has to approve of certain things. And that's as it should be. So I look at it with a political reality and it's very difficult for me to conceive that people are, most people have 401ks, most people have IRAs and in the US system you're promised a certain benefit.

Now would the population just simply give up that benefit and allow for a tax increase without raising a ruckus about it? I don't know. That one's hard for me to know. And so one of my research projects that I've been trying to do is trying to get a handle on that question.

I still don't have a handle on the question. I was surprised at how little outrage there was last year when President Obama in his budget proposal proposed taxing IRA accounts over a certain amount. Now that hasn't come to fruition. Still gotta get through Congress and same thing. But I was surprised how little outrage there was.

And I've wondered if maybe that weren't a bit of a precursor, something I need to pay attention to. It's very difficult for me to know how to answer that question at this point. But that's the reason why I'm going to the history here of the 529 accounts. Because I never had time when I was a practicing financial planner, excuse me, I never made time when I was a practicing financial planner to go through and try to figure out some of the history of these types of accounts to figure out how in the future context things could change.

But now in preparation for shows like this, I can do that. So let me give you the history of how these accounts came to be. They, unlike most programs, these accounts were actually begun at a state level, specifically with the state of Michigan. And Michigan in, was it late, no, during the 80s, Michigan had an idea to try to help control the costs of tuition.

And from the periods of the 70s and the 80s, there were massive increases in the cost of college tuition. You can fact check me, but going off of memory, I think for that period, the annual increase in the price of college tuition was about somewhere around 9% for much of those two decades.

So the state of Michigan came up with a plan to create a prepaid tuition program. And essentially their idea was to establish a fund into which the residents of that state could pay money at a fixed rate in exchange for a promise that the fund would pay for the tuition at a Michigan government run college or university.

So this would have been pretty attractive because it allowed you to control a cost of, to rein in a no for a fixed cost today, something that is an unsure, it's unsure how much the price is gonna increase in the future. Which incidentally, make sure you connect the dots between that and the alpha strategy, which I've spoken about on this show, which is in essence, one way to control the increasing cost of certain items, especially items that are heavily subject to inflation, is simply to purchase the item.

And the benefit of doing it this way is you lock in, you lock it in for a known cost, and because you have a need for the item, no matter what the future increase or decrease might be, you actually have, you still need it. So even if the benefit, even if inflation doesn't go away so much, you still need the item.

And so you've got a guaranteed floor on your need, on your plan, that didn't come out quite as clearly as I was intending. In essence, what I'm saying is that your downside is limited. If you need socks and you calculate that I need a certain, you know, I need three pairs of socks every year, and you decide to buy five years worth of socks, you know that you're gonna need the socks, and you go ahead and buy them today, you can't possibly lose because you've gotten a fixed price for something that you need.

Now, even if socks go down in price, you still have the socks. Gonna move on 'cause it's coming out in a clumsy way, and I'm not able to articulate it better at the moment. So this is what the Michigan, the state of Michigan tried to accomplish with their Michigan Education Trust.

What was unsure at that time was how the taxation would work. There's an interesting court case, which I'll post a brief to in the show notes. But this court case has, it was state of Michigan, it's Michigan Education Trust versus the United States of America. And this court case has the details and the facts of the factual background of this trust fund.

So before actually opening the fund and accepting applications, the Michigan Education Trust did ask for a private letter ruling from the IRS as to whether the accrued investment income would be exempt from federal taxation. It wasn't clear in the tax code at that time. So the IRS issued a private letter ruling, and their decision in that private letter ruling was that the Michigan Education Trust was created as a corporation, and that therefore its income was subject to federal taxation.

So the way it would have worked is that the purchasers of the contract were not going to be taxed on the accruing value of the contract until the funds were actually distributed to them or refunded to them if they didn't use them. But that the trust fund would pay tax on the growth of the investments.

So they would pay annually the tax on the growth of the funds. So the trust opened for business, and it worked exactly like that. The individual signed up, about 55,000 people immediately signed up for the program, and the trust paid each year federal income tax on its investment earnings.

But in May of 1990, the trust sued the IRS seeking a refund of their payments. And they argued that the income was not, we should not have been subject to federal taxation, and they requested a refund of all of the tax payments plus interest from the time of date of inception up until the lawsuit.

And then in July of 1992, the district court found in favor of the IRS, said it was subject to federal taxation. The trust appealed it, and then ultimately, the court actually reversed the district court's summary and found that the Michigan Education Trust was a state agency. And as a state agency, as compared to a corporation, its investment income was not subject to federal taxation.

And ultimately, there was another lawsuit filed about the timing of the refund from the IRS, and ultimately, all the money was returned to the educational trust. So this was fought in court. Well, a lot of other states were watching this, and so Congress decided this is a pretty good idea.

And so they went ahead and clarified it by passing new legislation. And that new legislation became Section 529. And this legislation authorized the qualified tuition programs, qualified state tuition programs. And it was passed as part of the Small Business Jobs Protection Act of 1996. And essentially, it allowed tax exemption to state-run programs if they qualified, and the tax deferral on the undistributed earnings from the account.

That fit into the, so that fit in, and Section 529 was passed as, also, excuse me, I'm not sure which part was in the Small Business Jobs Protection Act of 1996, and then the Taxpayer Relief Act of 1997. So the Clinton administration brought in Section 529 and the Taxpayer Relief Act.

And it made a number of other changes associated with education. But one change is in that bill, there was a suggestion to make the distribution from 529 accounts tax-free, not simply tax-deferred. Bill Clinton vetoed that. So the way this worked at that time was that you put money into it, the investment earnings were tax-deferred until distribution, but at distribution, taxes were due.

So it was much like, for example, annuity taxation today is very similar. You put it in, there's no deduction on the front end. The money can grow, there's tax deferral all the way through as the money grows, and then at distribution, the tax is due. The proposal was to make the growth completely tax-free.

Bill Clinton vetoed that. In 2001, however, Congress passed the Economic Growth and Tax Relief Reconciliation Act, known as EGTRA, and that was signed into law by President George W. Bush. And what EGTRA did was it allowed all of the distributions from these accounts to be excluded from income when they were used for a qualified higher education expenses.

There were a number of other changes as well. For example, this expanded the access for special needs beneficiaries. It made these plans available for private institutions as well as public institutions, and there were some other changes as well. But the primary one was it made these tax-free. However, all of the proposals in that law were scheduled to sunset, and they were scheduled to sunset on December 31, 2010, and it was scheduled to revert back to how it was prior to that 2001 law.

In the Pension Protection Act of 2006, there was a provision that made all of those changes to Section 529 from EGTRA in 2001 permanent, including the tax-free treatment for qualified distributions. So that's how it stands today. Since that time, I mean, these plans have grown massively, and that's a huge difference as far as tax-free versus simply tax-deferred.

And so these plans have grown massively, and they're very, very popular, very, very popular today. Now, the challenge is that in the most recent budget proposal from President Obama, this is one of the proposals that is on the table, that he is proposing in his budget to change. I personally had been waiting until the State of the Union address to review some of his recent proposals, and I reviewed the transcript, and I didn't see anything about this, but then in researching it further after and with the help of a listener on the Facebook page, it was on my research list, but I just, I crowdsourced.

And I was able to dig some stuff out of the budget, which they'd leak at a Friday night before a holiday weekend. Nothing suspicious about that. Political games. Anyway, so the proposal is to go back to that 2001 number. Here are the actual numbers of what happened, though, when that tax law changed, is according to the College Savings Network, in 2001, assets in 529 plans were $13 billion.

In 2002, they doubled to $26 billion. And presently, as things stand today, there are approximately $245 billion in these 529 plans. Now, and then there's an average balance of about $21,000 in the plans with about 12 million accounts open. Now, the interesting thing to me is just simply the proposals and the changes.

Now, certainly this is not law. It has to go through a period of time. If it does, we'll see. Who knows what happens? But it's certainly not something that is, it's certainly not something that, it's not out of the realm of possibility. What I don't understand is why this is part of Obama's agenda with all of the other focus on education.

You would think, I would think, that this would be a pretty safe one. After all, he's trying to cut costs all over the place. So I don't personally get why this is a part of his agenda. I tried to research some of the liberal approaches to see, and the best I was able to find was Slate Magazine has an article.

The headline was "Obama Wants to Tax College Savings Accounts "and It's a Great Idea." And the author of this article is, cites data from the Government Accountability Office, which says that a majority of people who participate, 47% of families that participate in 529 plans are covered out educational savings accounts, earn in excess of $150,000 a year.

I hate this cherry pick stuff. Of course they do, 'cause who else can afford to set aside money and is actually gonna take the time to plan for college accounts? Do you expect a single mom earning, or a single dad earning $50,000 a year to have the excess cash flow to tuck aside 15,000 bucks in a 529 account?

People don't plan, and there's no reason for it. When there's tons of free money for college, why should you save for it? Anyway, I'm trying not to go into the politics of it, but it, I don't know, it doesn't make a lot of sense to me why that is.

But the biggest thing about it is, it's an illustration of how you have to be careful with these accounts. And it, I try to stay out of the politics, but it is increasingly frustrating to me to have to deal with this stuff. And it's always the same. But if I could find another, I think about sometimes of going to other tax jurisdictions, if I could just make a law and keep it, and get rid of all the deductions, get rid of all the credits, get rid of all the accounts, and just pass a straight up tax of a certain amount and base it on income.

And then, whatever. I don't, it's just, it's difficult to plan. 'Cause how do I as a financial planner tell people, here's what you should do? If this goes back, there's not a chance in the world I would ever recommend a 529 plan again. It's a waste of time. And the reason it's a waste of time is because even just under this, under the Obama proposal, according to what I've read on it, I looked at the budget, but it was unclear, but he wants to go back, he wants to be taxed as ordinary income.

Well, in that situation, why would you ever put post-tax dollars in, defer it, and then pick up those dollars as ordinary income? It doesn't make any sense at all to me. But welcome to our modern world. And, (laughs) welcome to our modern world. So that's a little bit of the history of the 529 plans.

Where things are gonna go, at the moment, the law is as it is. Is Congress likely, are they ever likely to do anything? I don't think so. The best thing that can happen at this stage is, and hopefully this will happen for the next two years, is you just have massive gridlock, and then Congress can do nothing and we can get on with our lives.

But we'll see, who knows? These things, you gotta keep an eye on it. And again, you gotta do it in terms of scale. Would I lock up my money for $100 a month and run the risk of that, and have the money tied up in this 529 account with that?

There's not a chance in the world under this scenario. Now, would I consider using this account as part of a comprehensive plan if I were more affluent? Might, I might. That's my best shot at it. Prior to this budget proposal, I was a much bigger fan, because when you can get a law that's set and it's not scheduled to sunset, that gives you some ability to plan.

But now these things are back on the table, it's certainly frustrating. That is what I wanted to cover as far as the history and the introduction. The next stage in my outline here is we're gonna go through the detailed rules, and so that you understand how these rules work.

And this is gonna answer what expenses can you pay, all of that. This is actually where I stopped yesterday, but I'm gonna continue on since I didn't release the show yesterday. I'm gonna cover here what the IRS publication 970, which is their publication on education, tax benefits for education, has to say about this.

And it's actually remarkably short. In this publication, there's only four pages of information on the qualified tuition programs. Of the actual legislation, if you wanna go and read it, it's remarkably short as the internal revenue code goes. I've got it printed out here in my notes. It's six pages, and a lot of it is double-spaced.

So there's not a lot to it. The major challenge with 529 plans is the application, and especially the nuance with state income tax deductions. So let's boogie through just some big picture details, and then we'll get to the application in another show. I've explained enough of the details that I don't need to go through all of them again.

But I do need to give you a few specific scenarios. The first thing we need to do is define what are qualified education expenses. So the money that comes out of these accounts comes out under current law tax-free if used for a qualified education expenses. And here's the definition.

Qualified education expenses are expenses that are related to enrollment or attendance at an eligible education institution. And for the purposes of a qualified tuition plan, this is an eligible educational institution. Is any college, university, vocational school, or other post-secondary educational institution eligible to participate in a student aid program administered by the United States Department of Education?

It includes virtually all accredited, public, non-profit, and proprietary, meaning privately owned, profit-making, post-secondary institutions. Now this is a very interesting definition because it brings up one of the unique wrinkles of a 529 plan. And one of those wrinkles is how do we get out, how do we use the money?

There is a method where you can actually use this money for yourself. And you can use it for expenses that are associated at an eligible educational institution. But that definition, which includes programs that are administered by the US, that accept student aid programs administered by the US Department of Education, opens up kind of a unique option.

This appeals to me and it might appeal to some of you who are interested in things like global travel, perpetual travel, that type of thing. I knew about this potential loophole and I mentioned it on a previous show and then I realized I hadn't gone and looked up the list.

And so then a listener named Benjamin commented on a recent show where I had mentioned it, which was episode 118, where during a Q&A show, I talked about using a 529 account to go ahead and pay for tuition at a university in a foreign country. And pay for tuition and room and board.

So this would be something that would appeal to somebody like me, is I love to learn and I would love to study at a foreign institution. And so Benjamin found me the list of eligible schools that are eligible in other countries. And there are tons of these. So in Australia, there are 22 different universities.

Here's one in Austria, here's one in Bulgaria. There are about a gazillion in Canada that are covered, well, gazillion is 71. There's one in China, Costa Rica, five in Czech Republic, Denmark, three, Dominica, one, Dominican Republic, five, Egypt, one, England, a bunch. So there's all these different universities, Oxford University, France, there are, looks like a total of nine universities which are eligible for the US, for US federal financial aid.

So what that means is, remember in the previous Coverdell Educational Savings Account show, I talked about how easy it is to get the money out of the ESA and just put it into a 529. With a 529 plan, there's no restriction on age. So the money can sit here for a very long period of time.

And you can make yourself the beneficiary of it. And I personally would thoroughly enjoy going and enrolling at the Institut d'Etudes Politiques de Paris in France, or the American University of Paris, or American Graduate School in Paris, and live and study in France, and use these tax-deferred 529 dollars to pay for my room and board, and I could find room and board on campus for me and my wife, and pay for our tuition to study at business school in Paris, or study at language school, or go to Israel, or Italy, or Lebanon.

All kinds of universities here. And so this is a good way to think in advance about how do I use one of these tax-deferred accounts in a creative and unique way to fund what I'm trying to accomplish. Now the key is the expenses. What are the qualified expenses? Let me go through that.

Just like there was with the Coverdell Educational Savings Accounts, some of the expenses that are covered must be required by the institution, and then some of them must simply be incurred by the student. So the expenses that must be required by the institution to be eligible as a qualified educational expense include tuition and fees, books, supplies, and equipment.

So anything that's written on your syllabus for your college class that requires these specific books, these specific supplies, and this specific equipment, that's required and that's an eligible expense, and/or tuition and fees. It's important because one of the things that people ask a lot of times is what are covered expenses?

I had a recent question on a Friday Q&A show from a listener, and he was asking a question. He'd gone to and outfitted his son, I think it was his son, at an apartment, and he bought an office chair for his son's apartment, and he asked is that an eligible expense?

The answer is no. Only supplies and equipment that are required by the eligible institution. And because it's an off-campus apartment, then that's certainly not part of the expenses that are required by the university. Now, if an office chair were included as part of the on-campus apartment, as part of the furnishing of an on-campus apartment, that would be covered, which we'll get to in just a second.

This is that little notice about special needs, and so these expenses are appropriate for special needs clients. Expenses for special needs services, which are needed by a special needs beneficiary, must be incurred in connection with enrollment or attendance at an eligible educational institution. So the difference between required and connection is important.

So if you are or if you have a special needs beneficiary, any expenses that, for special needs services, that are incurred in connection with their enrollment or attendance at a university is eligible. So that could be a little bit broader as an example. In my mind, although you certainly cannot deduct commuting expenses, or you cannot pay for commuting expenses for a non-special needs student out of this account, because it's not required by the institution, I think that if there were special needs transportation services that were needed to get your special needs beneficiary from your house to that university, that would be an eligible expense.

So you can use a 529 account to allow you to purchase those services with tax-free dollars. Now, as far as room and board, let me read you this. Expenses for room and board must be incurred by students who are enrolled at least half-time. The expense for room and board qualifies only to the extent that it is not more than the greater of the following two amounts.

The allowance for room and board, as determined by the eligible educational institution that was included in the cost of attendance for federal financial aid purposes for a particular academic period and living arrangement of the student. Or B, the actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.

So for a mainstream US student, what this says is A, to pay for room and board expenses out of this account, you need to be enrolled at least half-time, whatever the definition of half-time is for that university, at least half-time. You can't be taking one class per semester and expect to pay for your room and board.

You could pay for the one class in tuition and fees and book supplies and equipment out of this account, but you can't pay for room and board expenses with only one class. But if you are at least half-time, then room and board is an allowable expense which can be paid for tax-free out of this account.

Well, up to how much? Well, it can be up to the amount that the student is paying if they're living in housing which is owned or operated by the college or university, no matter how much. So there's no cap there. Or if living off campus in other housing arrangements, then it can be as much as the institution includes in their cost of attendance for a particular academic period and living arrangement of the student.

So if the university calculates and says $10,000 per year is what we think a student will need to pay for accommodation, then a student can cover up to $10,000, excuse me, $10,000 per year is what we require and estimate for federal financial aid purposes as part of our costs.

Then the student in this scenario can live off campus and if their expenses are $12,000, they can pay for up to $10,000 as a qualified educational expense out of the 529 plan. Now, I would imagine that for some of you, especially those of you who are involved in real estate investing, there might be some ideas going off in your head when thinking about that.

And for the rest of you, there are now. So the fact that you can save money on a 529 account, grow that money tax-free, and then take the money out of the account and use it to pay for room and board expenses up to a certain amount, that's unique.

And there are some planning opportunities there for some of you. So whether that just simply means your child, again, is living in an apartment, is just simply paying rent, as long as it falls underneath those amounts that are established by the institution, which the nice thing about that is that we're gonna be regionally based.

So if your child is paying rent in New York City or is paying rent in Biloxi, then there's a little bit of a difference there as far as what those costs are gonna be. That's useful. Could you buy a house and have your child rent from you and pay for the rental cost out of the 529 out of his or her 529 account?

Yes. You have to follow that through and do everything properly, but you can. Can your child buy a house and pay for the expenses, pay for the mortgage and the interest costs and the taxes and the insurance out of the 529 account? Yes. You have to follow the rules, but there are some planning opportunities here.

You've gotta figure out what's worth it to you, and here's where the challenge is with all of these kinds of ideas. Sometimes an idea is pretty cool, and sometimes it's like, man, this is a total waste. I like to think in terms of the ideal scenario. So I like to think in terms of how could I use this account, tuck the money aside, okay, my child is enrolled, half time, at least half time, and then they're gonna do that while they're, to go ahead and finish off the university degree or need for education, but they're doing it while they're building a business.

They're going to school half time while they're building a business on the side, and they're studying something that they're very interested in, and they're going ahead and using these 529 money, which has grown over time, tax-free, to pay for their mortgage and get them established with their first house, and that's a good way of transferring the money.

That can certainly work, and you can take it from here and go, maybe I'll come back and I'll talk about some more of these ideas. I'm gonna do a whole show on some of the ways that you can essentially play with some of these systems, but hopefully that gives you enough of an idea, at least what the requirements are.

Tuition and fees, books, supplies, and equipment must be required. Special needs services just must be incurred in connection, and expenses for room and board, they have to be enrolled at least half time, and it can't be more than the greater of either the actual amount, if they're living in on-campus university housing, or what they use for their federal financial aid filings.

How much can you contribute? We've covered that already. You can contribute from, you can contribute up to the, well, I need to give you more detail on this. The contribution limits vary, depending on which type of plan you're participating in, whether you're using the plan that is for private colleges, or whether you are using a plan for public colleges, whether you're using the savings plan.

In essence, though, the amount cannot be more than the amount necessary to provide for the qualified education expenses. There are no income restrictions on who can contribute. So if you make $2 million a year, you can contribute to this account, but you cannot be more than what is needed for each beneficiary.

So if you only have one beneficiary, don't put $3 million into this account. That's not gonna work. But you can add multiple beneficiaries, and you can change the beneficiaries along the way. Losses. If you do have a loss in a qualified tuition program account, yes, you can take the loss on your income tax return.

After all of the money has been distributed from the account, if you have a loss, then you can go ahead and take that. Now, the IRS says in publication 970 that this comes in as a miscellaneous itemized deduction on Schedule A, and this is subject to the 2% of adjusted gross income limit.

That's what they say. That is less advantageous than simply an ordinary loss. Now, interestingly, even though the IRS publication says this is where you can claim it, from my research, this indicates that there are some tax experts who disagree, and based upon studying the code, say that you can take it as an ordinary loss.

But to the best of my knowledge, this has not yet been litigated. So if or when it is litigated, that would be important to know, I guess, before the tax court and see what the decision is. But if any of you are aware of any additional information on that, feel free to comment on today's show notes and let me know.

But at least the point is, you can take losses. Distributions. The interesting thing about this account is there are a couple different things you gotta calculate, whether or not the distributions are taxable. And there's a difference between taxable distributions and penalized distributions. So let's talk about whether the distribution is taxable or not.

In essence, when you boil the rules down, if you have a distribution from the account that exceeds the adjusted qualified education expenses, it will probably be taxable. Now, the challenge is that the adjusted education, excuse me, the adjusted qualified educational expenses number is the total qualified education expenses which have been reduced by any tax-free educational assistance, including any tax-free scholarships or fellowships, any veterans educational assistance, any Pell Grants, any employer-provided educational assistance, or any other non-taxable payments other than gifts or inheritances that have been received as educational assistance.

So you've gotta work out and see is there a taxable distribution or a non-taxable distribution. As part of that planning, you've gotta look at also how to coordinate the expenses, the qualified educational expenses, with other tax credits that you may be taking. So you might be coordinating this with Coverdell Educational Savings Account distributions or coordinating it with American Opportunity and Lifetime Learning Credit distributions.

And you'll find out if some of the distributions are taxable or not. It's possible to have a taxable distribution that does not also have a 10% additional penalty tax. But in general though, you're usually going to have a 10% additional tax if the funds aren't used for education. So this is one of the key points.

We're getting a little nitpicky here and I'm not gonna go any deeper than that on the audio. If you have a specific planning scenario that you're trying to figure out, look at it with your own set of facts, with the actual numbers, and then refer to the IRS guidance documents and look at it with your own scenario.

The 10% additional tax, however, does have some exceptions. And so you don't have the additional 10% penalty tax for a distribution which is paid to the beneficiary or to the estate of the designated beneficiary on or after the death of the designated beneficiary. So the example here would be if I'm the beneficiary of an account and then I die and that money then is paid to my estate, it would indeed be a taxable event, but it would not have the 10% additional penalty tax.

The next exception is any payments that are made because the designated beneficiary is disabled. So if it's disabled, the payments can be made without the additional tax, the 10% penalty. Additionally, the penalty tax does not apply to payments that are included in income because the beneficiary received a tax-free scholarship or fellowship, veterans educational assistance, employer-provided educational assistance, or any other non-taxable tax-free payments other than gifts or inheritances which are received as educational assistance.

This is useful because it means that if you oversave for your child's college expenses or your child gets scholarship income, something like that, when the money is distributed, as long as the numbers of the expenses work out and the scholarship income, you follow the rules. But basically, whatever distributions that are made because they received a tax-free scholarship or fellowship, those distributions will not be subject to the penalty tax.

You will owe income tax, but not the penalty tax. So that's helpful. Then the fourth and fifth exceptions is any distribution that's made on account of the attendance of the designated beneficiary at a US military academy, and then also any distributions that are included in income only because the qualified education expenses were taken into account in determining the American Opportunity or Lifetime Learning Credit.

So it gets a little bit too tricky to try to explain in an audio format. But in essence, there are some ways to take some distributions from the account where you will owe tax on them, but you won't owe the penalty tax. In general, you don't wanna over-save into this account, but there are some exit plans as I have sketched out for you.

What if you do over-save? Well, one of the most useful things is that you can simply change and roll over the account from one person to another. So you can change the beneficiary on the account. And the people that you can change this to, the number of people is quite broad.

This is the most useful exit point. If your oldest child doesn't use the funds, you can just simply transition the funds to your next child and along the way. And so any kind of rollovers, there's no tax implications, the money continues to be sheltered and it can be passed along.

Here are the people to whom it can be passed to these members of the beneficiary's family. And so for the purposes of this rollover, the beneficiary's family includes the beneficiary's spouse and the following other relatives of the beneficiary. Son, daughter, stepchild, foster child, adopted child, or a descendant of any of them.

So we now said any descendant of the beneficiary. So if that's you, any of your descendants, if it's your child, any of your child's descendants, any descendant of any of their descendants. The brother, sister, stepbrother, or stepsister of the beneficiary. Father or mother or ancestor of either. Stepfather or stepmother.

So on the father, mother, stepfather, the father, mother, or ancestor of either. What that means is that if you set something aside for your child and you don't use the funds for their education, you can change the beneficiary to be you and you can do my retirement plan of getting a PhD in Paris out of the 529 accounts.

Any ancestor or even to your child's grandparent if they want to go back to school. Stepfather or stepmother. So it doesn't say ancestor of stepfather or stepmother, just stepfather or stepmother. Son or daughter of a brother or sister. So if your child doesn't use the funds but your child's brother has a son or daughter and they want it to go to them, that's allowable.

Brother or sister of father or mother. So meaning if your child is the beneficiary but you're their father or mother, your brother or sister is an allowable change. Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law of the designated beneficiary. The spouse of any individual listed above or first cousins. And that's the list.

So that's a fairly comprehensive list. So if there are in essence educational needs anywhere in your family, then this account can be used to fund those needs. That's the essence of how the accounts work. Now there are a number of specific detailed questions of implementation. And with 529 accounts, the key is not in how does the account work, the key, although that is a factor.

The key is in the application of it. How do you know, as an example, if your state has a prepaid tuition program that is financially viable and financially solvent? How do you select among, after all, the only 529 plans you can participate in are the ones that are sponsored by a specific state.

So how do you choose among different state options? How would you know whether Virginia's plan is better than Florida's plan, is better than Alabama's plan? How do you calculate the fees? And then one of the big ones is what about the state income tax deduction? Because this might be a compelling reason for you to participate in a 529, and it might be a total waste of time.

For me in Florida, we don't have state income taxes, it's a total waste of time, don't even think about it. But for some of you, this could be very useful to you. So we will cover those in future shows. I hope that was a useful intro to you, I kind of did a double header here with putting those information together, but I feel better about the flow of the show and my ability to convey the important points.

I know I got a little bogged down there in the middle with the political planning, but it is actually an important part of financial planning. In, when you're talking about risk for a portfolio, one of the major mistakes that many new investors make is they only think of risk on a one dimensional basis.

You know, the risk of market risk, for example. You know, the value of their investments going up or down. But there are many kinds of risk, and one of those, one type of risk is tax risk, so a change in the tax code. Another type of risk is political risk, a change in the political climate of an environment.

What do you do if you own an oil company, and you own stock of this oil company, and that company goes through a socialist revolution, and the government comes in and completely nationalizes the country? Excuse me, the company? It's happened, it's happened many times. So that's a risk. And so in personal financial planning, when you choose to participate in things like a 529 account, you have a risk.

President Obama, in cahoots with Congress, might change the law, and you might find yourself not sitting on a tax-free asset that you were planning on, you might find yourself sitting on merely a tax-deferred asset. Or, previously, you might have gotten in, and it might have gotten better, you might have gotten in under the tax-deferred plan, and found out that it was just a tax-free plan.

So join us for part two, and I'll start to go through how to make these actual decisions to your own, in your own scenario, and try to figure out what plans should I participate in, what state, okay, if I'm in this state, then how do I make these decisions?

How do these assets account for, you know, other aspects of my planning? Asset, I haven't talked about asset protection, I haven't talked about estate planning, so there's much more to this series, but we're gonna continue this masterclass on investments. Thank you so much for being with me today, I really appreciate it, and I hope you found this info valuable.

If you've got questions that you want me to answer for you as part of this show, come by the Facebook page, and you'll see a video that I posted at facebook.com/radicalpersonalfinance. Ask me your question, and I will make sure to include it in this show. If you'd like to support the show, join the membership program, I would be greatly indebted to you if you would do that, it will help me to continue bringing you this depth of content details at radicalpersonalfinance.com/membership.

Peace out, y'all. Thank you for listening to today's show. If you'd like to contact me personally, my email address is joshua@radicalpersonalfinance.com. You can also connect with the show on Twitter, @radicalpf, and at facebook.com/radicalpersonalfinance. This show is intended to provide entertainment, education, and financial enlightenment, but your situation is unique, and I cannot deliver any actionable advice without knowing anything about you.

Please, develop a team of professional advisors who you find to be caring, competent, and trustworthy, and consult them, because they are the ones who can understand your specific needs, your specific goals, and provide specific answers to your questions. I've done my absolute best to be clear and accurate in today's show, but I'm one person, and I make mistakes.

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. Until tomorrow, thanks for being here. - The holidays start here at Ralph's, with a variety of options to celebrate traditions, old and new, whether you're making a traditional roasted turkey, or spicy turkey tacos, your go-to shrimp cocktail, or your first Cajun risotto, Ralph's has all the freshest ingredients to embrace your traditions.

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