Almost a third of contributions to 529 college savings plans are made in the fourth quarter, but there are good reasons to contribute in the beginning of the New Year. The earlier you get the money in, the longer it has to grow tax-free. Also, some states will let you take a 2013 state tax deduction for contributions made up until April 15, 2014. And tax season—when you're preparing your taxes–is a good time to look at how 529 plans fit into your overall tax planning strategy.
Tax savings is one of the main drivers of 529 plan growth. You can get a triple, or even quadruple, tax break. The money you contribute grows federal and state tax-free and comes out federal and state tax-free if used to pay college expenses. By contributing to a plan you get money out of your estate, potentially saving on state and federal estate taxes. And depending where you live and which plan you pick, state tax breaks are available.
Stretching out tax-deferral. While the minimum contribution to open an account is typically $250, many high-net-worth families stash away tens of thousands of dollars. Grandparents who are forced to take required minimum distributions from retirement accounts but don't need the money to live on move the money from one tax-deferred account to another by setting up plans for their grandkids, says Kevin Farrell, divisional manager for RIA sales at SSgA (the investment manager for Nevada's 529 plan).
Side-stepping estate tax levies. Another strategy Farrell sees advisors implementing on behalf of wealthy grandparents and parents is accelerated gifting. You can give five years worth of $14,000 annual exclusion gifts at once—that's the amount the Internal Revenue Service allows as a tax-free gift from one individual to another. So grandma and grandpa could fund an account for a grandchild with $140,000 (multiply that times the number of your grandchildren), and it's out of their estate. A bonus: "You still have control over the assets until they're distributed," Farrell says.
The state tax breaks keep getting better. In 33 states and Washington, D.C. you can get a tax break for contributions to 529 plans, usually a state income tax deduction. North Carolina eliminated its deduction as part of a tax reform package last year. But the trend is still for states to make their deductions more generous, say Joseph Hurley, founder of Savingforcollege.com, which has state-by-state details here.
Arizona made its deduction permanent in 2012 and in 2013 increased it from $750 to $2,000 a year for individual tax filers and from $1,500 to $4,000 a year for joint filers. Nebraska increased its deduction from $5,000 to $10,000 for single filers and married couples filing jointly and from $2,500 to $5,000 for a married individual filing separately, beginning in 2014. Ohio and Wisconsin are considering improvements to their deductions, Hurley says.
Get a deduction for contributing to an out-of-state plan. Six states (Arizona, Kansas, Maine, Missouri, Montana and Pennsylvania) let you take a deduction for contributions to other states' plans. That's important because although your state's direct-sold plan might be the best, it pays to shop around on fees (look at the total for administrative fees and investment fees) and investment choices. Farrell says Nevada's plan is unusual in that it's an institutionally-managed portfolio of exchange-traded funds, which keeps the costs down. Basing your decision just on the tax breaks can be a mistake.
Timing your contribution and deduction. Most states match the tax year you get to take the deduction with the year you make the contribution. So if you make a contribution in 2014, you'll get the break on your 2014 taxes when you file in the spring of 2015. But a few states have an April 15 deadline—so there's still time in 2014 before you file your 2013 tax return to make a contribution and get a 2013 deduction. The April 15 deadline states are Georgia, Mississippi, Oklahoma, Oregon and South Carolina.
E-gifting.
E-gifting programs make funneling gifts from family and friends easier. TIAA-CREF launched e-gifting in California and Connecticut in 2012 and now offers it in all 11 states where it administers plans. Once you have an account, you can email your daughter's aunt a link where she can enter her banking information and make a direct contribution to the account. There is no administrative fee for the TIAA-CREF e-gifting service (watch out for fees at some third party 529 gift conduit services). Note: If Aunt Sally makes the contribution directly to the 529 account, she gets the potential tax break, allowing her to essentially give more.
See also:
Paying For College: A 21-Step Guide To Preserving Wealth
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