All You Need to Know About 529 Plans

All You Need to Know About 529 Plans

If you don’t have the right plan for distributions, all of the advantages of a 529 Plan could end up costing you thousands.

Congress created 529 plans in 1996 and they are named after section 529 of the Internal Revenue code. They are plans operated by a state or educational institution, with tax advantages and potentially other incentives to make it easier to save for college and other post-secondary training for a designated beneficiary, such as a child or grandchild. Each state has its own, unique plan and they are allowed to offer both types of plans: prepaid tuition and savings plans. You are not restricted to your own state’s 529 plan. Your state may offer incentives to win your business, but the market is competitive and you may find another plan you like more. Be sure to compare the various features of different plans. You may have to “recapture” some of your deductions if funds were not used for secondary learning.

Each 529 Plan account has only one designated beneficiary, usually the student or future student for whom the plan is intended to provide benefits. The beneficiary is generally not limited to attending schools in the state that sponsors their 529 plan. But to be sure, check with a plan before setting up an account. Earnings are not subject to federal tax and generally not subject to state tax when used for the qualified education expenses of the designated beneficiary, such as tuition, fees, books, as well as room and board. Contributions to a 529 plan are not deductible on your Federal tax return; however, most states allow deductions if you use their plan (Michigan has the MESP that allows a deduction of up to $10,000 for married couple, $5,000 for single).

TAX TIP – There are Federal Estate and Gift Tax Benefits for contributions into a 529 plan. The contributions can lower the overall value of the estate as well as qualifying for the annual federal gift tax exclusion (remains at $14,000 per spouse per beneficiary). Taxpayers can gift up to 5 years at once ($140,000 for married couple) and still be excluded from gift taxes. The maximum amount you can contribute is $235,000 for each beneficiary. You can transfer beneficiaries so long as they are a relative of previous beneficiary.

Accounts can be opened by anyone who is a US Citizen and has reached the age of majority (18). The funds can be used for any secondary school and not just for higher learning institutions in your state. Withdrawals need to be disbursed in the TAX YEAR that the qualified higher education expense were paid. You generally have three options when requesting a distribution from a 529 plan: 1) a check made payable to the account owner, 2) a check made payable to the student or 3) a payment made directly from the 529 plan to the student’s college.

TAX TIP – Consider having the check made payable to the student. They will receive a 1099-Q tax form reporting the distribution to the IRS showing the student’s name and Social Security number. If the student incurs qualifying higher education expenses, or QHEE, during the calendar year that are equal to, or greater than, the gross distribution figure on Form 1099-Q, the distribution is tax-free. And when all 529 plan distributions in a year are tax-free, nothing is shown on the student’s Form 1040.

Another reason for preferring the second option concerns situations where the earnings portion of the distribution is fully or partially taxable because the beneficiary has insufficient qualified educational expenses. This can occur, for example, because the beneficiary received a scholarship and the account owner made a decision to pull unneeded funds from the 529 plan. It’s important to note that taxable distributions avoid the usual 10 percent penalty to the extent the beneficiary received scholarship monies.

TAX TIP – By making sure the distribution is reported to the beneficiary, the earnings are taxed at the student’s tax bracket, which is typically much lower than the account owner’s bracket unless the so-called “kiddie tax” applies. The kiddie tax requires certain children as old as 23 to pay tax on unearned income at their parents’ tax brackets.

Be careful of directing the 529 plan to make payment directly to the school. Those payments will be treated in much the same way that outside scholarships are treated. If the student is awarded a needs-based financial aid package, the school can adjust that award downward on a dollar-for-dollar basis. Be sure you ask about the policies at your child’s particular school beforehand.

Funds can be used for tuition, mandatory fees, books, supplies, and equipment required for enrollment or attendance, certain room and board costs, and expenses for “special needs” students.

A qualified, nontaxable distribution from a 529 plan includes the cost of the purchase of any computer technology, related equipment and/or related services such as Internet access. The technology, equipment or services qualify if they are used by the beneficiary of the plan and the beneficiary’s family during any of the years the beneficiary is enrolled at an eligible educational institution. This means any computer and related peripheral equipment. Related peripheral equipment is defined as any auxiliary machine (whether on-line or off-line) which is designed to be placed under the control of the central processing unit of a computer, such as a printer. This does not include equipment of a kind used primarily for amusement or entertainment. “Computer technology” also includes computer software used for educational purposes. Such costs are generally not qualifying expenses for the American opportunity credit, Hope credit, lifetime learning credit or the tuition and fees deduction.

TAX TIP – There are no income restrictions to contribute to a 529. There is no time limit for the assets to be in the 529 plan and no age requirements for withdrawal. Assets in a 529 plan are not used in calculating RMDs and you can always use your RMDs to deposit into 529 plans.

Taxation and Withdrawal Strategies

Only the earnings portion of a non-qualified withdrawal is subject to a 10% withdrawal penalty. Distributions are allocated on a pro-rate basis, which means that withdrawals will be divided into contributions and earnings based on the formula:

Account Contributions / Account Value X Distributions = Contribution Portion

Please note your contributions will never incur a penalty, and only the earnings portion is ever taxed.

There are a few exceptions to this 10% penalty on non-qualified withdrawals; if the beneficiary dies or becomes disabled; if the student attends a US Military Academy; or if the student receives a scholarship. All earnings on non-qualified distributions will be subject to tax as ordinary income at your tax rate. Withdrawal rates for most 529 account owners is 100% of qualified expenses MINUS $4,000 (American Opportunity Tax Credit – AOTC). If you don’t, you could be facing a 10% penalty plus adding $4,000 to your AGI. There is an income-phase out where the owners of the 529 cannot claim the AOTC so they would not have to adjust for it.

TAX TIP – End of year tax planning, owners of 529 plans should sit down and calculate exactly how much was spent on qualified expenses and make appropriate reimbursement distributions from the 529 plan. Maximize the AOTC by considering paying tuition bill in December rather January.

Most 529 plans allow you to take withdrawals yourself, send the withdrawal straight to the beneficiary or paid directly to the university. Whoever receives the check will receive the 1099-Q representing the distribution. It should not matter for as long as the qualified expenses supported the distribution but the funds received were too much then the distribution becomes a taxable event. One thing to consider, if the institution receives the check, it may treat it as some sort of scholarship, and could reduce the student’s financial aid package.

It is extremely important to have the right strategy going in so you can have the right results coming out. We can help you determine the right amount either in lump sum or over time to contribute, the right plan and the investment choices each plan brings and we will help you plan the right course of action for your distributions.

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Why NOT Budgeting for Home Maintenance Can Be Detrimental to Your Retirement

How much should I budget for annual expense on the general maintenance of my house?
Where most people ‘take it for granted’ until they need to replace the windows at $300/pc or the roof at $10/sqft. And if you retired and most of your money is in your IRAs, now we have to add taxes in top of the cost.
While conducting one of our Retirement Planning classes here locally, one of our students had an interesting question regarding how much he should budget for the general maintenance of his house. This is a question that usually arises when we are putting an income plan together in order to bring a couple successfully through retirement. It also happens when we are putting together an estate plan and the trustees want to set aside money specifically for the upkeep of their home so their beneficiaries don’t have to sell home before they are ready. They understand that at any time you ‘have to’ sell anything, especially a large ticket item, the buyer wants a pretty good deal.
There is a general rule of either 1% of your purchase price (Current Market Value) or about $1 per square foot of living area. The living area should include your basement, attic and garage in this calculation. For example: 2 story Colonial with a two car attached garage and full basement. If your assessed size of your home is 2400 sq. ft. then it is safe to assume you have 1200 sqft on the top floor as well as the main floor and the basement. So realistically, you are looking at a potential 3,600 sq ft of living space. A two car garage is usually about 440 sq ft. So if you add it all up, you have a little over 4,000 sq ft that should go into this calculation and not simply the square footage you originally purchased your home.
So the range in which to implement your budget is anywhere from 1% of the purchase price to $1 of the entire square footage of the home. In our example, assuming homes are selling for $100 sqft, and you bought your home for $240,000. The bottom end of your budget for home maintenance should be $2,400 and the top end would be $1 of the total square feet or $4,000.
Now let’s talk about the $100 per sq ft. If we place this as a par value, we can simply investigate what homes are currently selling for in our neighborhood to see if we are above or below that factor. For instance if we find that a similar 2400 sq ft home just sold for $220,000 then we know immediately that is below par value (22/24 = $91.67 sq ft). We would then budget at either 91.67% (2400*.9167) which is $2,200 or (4000 sqft * 92 cents) which is $3,680. Of course our budget would work the opposite way if we find that our home is currently valued above par. For example a similar home sells for $300,000 or 125% above par so our bottom end of the range is $3,000 while the top end is now $5,000.
So why the difference? How does the market value per square feet have any effect on my maintenance cost? When considering a budget for your home there are Geographic Cost of Living, Quantity and Quality of products and services, and level of outside influences as main contributors in how current market fluctuations effect the day to day maintenance costs of your home. More affluent neighborhood stores sell products at a higher premium compared at lower income neighborhoods. Those same stores have more specialized products versus more generic brands to choose. More affluent stores have better opportunity to buy in bulk compared to lower income demographic stores where premium is placed on smaller packages that fetch a lower investment from the customer. Bigger homes usually have more amenities, landscaping and changes in construction materials that add a higher ongoing maintenance cost.
Other Considerations that will affect your long term budget when you purchased the home:
 Age of the house, roof, windows, additions etc
 Age of the appliances, hvac, plumbing, electrical
 Construction of home, vinyl siding, brick, stone etc
 Ongoing maintenance prior to purchase
 Proactive Maintenance, protective paints and seals, and waterproofing
 Warranties on appliances, maintenance
 Topography of home, high ground or valley, windy with no trees or surrounded by trees
 City Water or Well
 Weather extremes
It doesn’t seem that it should cost that much to maintain a home? You’re right it doesn’t seem to but let’s look at the list:
Age of Life for
 Roof – 20 years at about $9/sq ft that is $22,800 ($1140/yr)
 Furnace – 15 to 20 years and will cost about $2500 in today’s dollars ($125/yr)
 Hot Water Heater – 10 years at about $500 ($50/yr)
 Water Softener (if applicable) – 10 to 15 years at about $500 ($35/yr)
 Central Air – 20 years at about $4000 ($200/yr)
 Sprinkler System 30 years at about $2500 ($85/yr)
 Driveway 30 years at about $9000 ($300/yr)
That’s a total of about $1935 in today’s dollars and with the rate of inflation at 2.5%, most of these costs will be quite a bit higher. In 20 years, this monthly maintenance fee will be approximately $3100. While budgeting for the long term maintenance, the day to day maintenance now has a range of approximately $465 and then topped out at $2,065. It’s tuff to take ownership and stick to a budget, especially when there is a chance you may never need it. But as my mother always told me as I scoffed at the umbrella on the way out the door, it is better to have and not need it than to need it and not have it.

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Why Understanding the Cost of Doing Business and Not Performance should be the first priority when deciding what to do with your Rollover IRA.

“A capacity, and taste, for reading, gives access to whatever has already been discovered by others. It is the key, or one of the keys, to the already solved problems. And not only so. It gives a relish, and facility, for successfully pursuing the [yet] unsolved ones.” – Abraham Lincoln

Most financial advisor’s talk is about performance. How they can outperform the market or outperform their peers. They will also extol about the need for diversification because investing across asset classes will lower market risk thus reducing volatility. Then there is more talk that all portfolios need to have proper Asset Allocation so you can be in position for growth, wherever that my come. The final push is about downside protection either through a fixed annuity or an automated exit strategy where your portfolio goes to cash as soon as your losses cross a certain, pre-determined level.
While those are all very important factors to determine your financial strategy, there are two un-talked-about risks to consider, even if you ultimately decide to do nothing at all… The late actor Gary Collins’ most famous quote, “We can try to avoid making choices by doing nothing, but even that is a decision.”
Opportunity Risks and Unknown Risks
Opportunity Risk happens when you decide one way or another. It is invariably an action that presents other decisions that could have been made with the possibility of a more favorable outcome. Calculating and measuring the performances of any decision now becomes the focal point of any financial discussion. Words you will most likely hear or read is what is the average rate of return. It is how financial advisors sell their portfolios of mutual funds, professionally managed accounts and the value of hiring their services. Even though they are grammatically correct, how you understand the true growth of your investments should be at the foundation of your decisions.
Fool’s Gold
Let’s take the example of buying a certain mutual fund which, over the past 10 years, has an average rate of return, of say, 8.5%. The discussion then, is about the portfolio should realize an average of 8.5% per year but that is not the real math:

 

The numbers in the left column are actual historic returns of a mutual fund over a 10 year period where they report their mutual fund produces an average rate of return, which is true if you take those numbers, add them up and the divide by 10 and you will have an average of 8.5%. The natural tendency is to think, you will make on average 8.5%; however, that is not the case. The middle column follows the annual rates of return of the mutual fund. The actual rate of return of investing $100,000 ten years ago is 8.17% because if it truly was 8.5%, your mutual fund should be worth $226,098.
Now I get it, this difference seems insignificant, but you incorporate this into a bigger portfolio over a longer period of time and the difference can be quite substantial. Besides, we are looking at the true value of risk, so wouldn’t the true appreciative nature of the investment need to be known?
“Unknown” Risks should really be titled, “we know that these risks are out there but they won’t happen to me” risks. As a recovering CFO, I can’t help but institute some basic business fundamentals in a portfolio such as prioritizing income and assets into short term, not-so-short term and long term. In other words; “Cash on Hand”, “It May take a Phone Call” and “Can’t touch it with a 10 foot pole”. Now the accountant in me would say this is “Fund Accounting” where income brought in has a specific purpose and is handled accordingly while the financial advisor in me would call this “Sequence of Returns” where you do not ever distribute money out of an account that can go down in value.
Unknown risks also have another weight that seems to go unnoticed until you have been carrying them too long or they just get too heavy; and those are the Costs of Doing Business. Costs come in two flavors, voluntary and involuntary. The funny thing about voluntary costs is sometimes it is easy to think that they are supposed to be there, permanently.
Examples of Involuntary Costs
Service Costs, these are such things as various account fees, prep fees and transfer fees. We don’t like them, but almost always they are involuntary, unless of course you get someone else to pay them for you. You won’t know, until you ask.
Other Costs of Doing Business are a blend of involuntary and voluntary because these fees are associated with each product you choose to invest in, but that’s just it, you choose. You can always choose to do nothing and incur no cost. Each type of products ranging from mutual funds and ETFs to professional money management to life insurance fees have an even wider range of fees and it is up to you to investigate all of the fees inherent in each investment. ETFs have an average annual fee of less than 1% while mutual funds average almost 2%. What do you get for the difference? You receive more ‘active’ management of the stocks, bonds and cash within the fund to hopefully have more of an opportunity for capital appreciation (you make more money). Stocks, Bonds and Options usually have a buy/sell/get yourself into commission AND the spread between the Bid and the Ask (in stocks); difference in either coupon rate or yield (in bonds); or difference in strike price or the Bid and the Ask (in options). They won’t teach you that in the wire house conference room.
Please be careful of insurance products, there needs to be a conscious effort on your part to get ALL of the fees, explained, clearly concisely and up front before you surrender your assets to an insurance company. Now don’t get me wrong, there are a lot of great products from insurance and I am a big proponent of the right leverage for the right situation for the right price but I have seen how unknowing people have obligated themselves to some pretty expensive mistakes. To understand what I am trying to convey, it would be like your car to the neighborhood mechanic… you can pay them to diagnose your car, give a quote on how to fix it and decide from there if it is worth what they are asking. By now you have gone through a tremendous hassle getting to the mechanics shop, wasting an entire morning and shelled out a bunch of money already, who wants to do this again so you’ll probably do what 99% of us do, “Go ahead and Fix It.” But before you do, get a detailed quote on every part, labor warranty, tax and anything else that could cost more money. Sometimes, like an insurance product, there are some things you can do without fixing.
“I Signed Up for What?”
Voluntary costs can sometimes feel involuntary and downright intrusive, but nevertheless, as the buying public we come to desensitized acceptance of certain ways of business, so paying a certified tax planner $3,500 or an estate planning attorney $2,000 seems all so reasonable. So the question becomes, when does a cost become an investment? Simple, when the value outweighs the expectations. As a Certified Tax Strategist, it is part of my DNA to look at the cost of things. Why did we incur the cost? Are we going to keep incurring the cost? And is it worth it?
Now, as people come in who are looking for retirement planning or asset management they all understand that there will be costs involved. Clients understand we are all here to make a ‘decent’ living, some more decent than others but still the same, people recognize there is some remuneration somewhere.
People pay for the Cost of Advice either to the neighborhood broker or financial planner who works as an independent, for a bank, a wire house and just recently, an on-line brokerage firm. They will charge you a fee for service with a percentage based on household assets under management or by the hour or a flat fee for a ‘project’. All is good, as long as the value outweighs your expectations, but there are somethings to consider, especially as you rollover your IRA.
Normally, rolling over an IRA is a pretty big deal because it normally represents a significant if not all of a person’s nest egg. The asset base they are counting on to grow adequately to bring enough income to keep the expected life style and to pay for anything life throws at them. Here are some key considerations that can derail the success of your retirement:
Fees to any financial advice, either directly or embedded are PAID FIRST. Just like in the classic battle of the A-Share versus the B-Share back 10+ years ago, it is in the best interest of the financial firm to be paid before the assets are invested so the client absorbs all of the risk.
The more layers of professional management, the more costs associated with financial advice. You hire a financial advisor who charges a 1% ‘management fee’ to oversee and recommend your investment portfolio; they hire a professional money manager with a 20 year track record who charges 1% (either directly or embedded and then that money manager buys mutual funds which have another 1.5% embedded fee. So your assets can have 3.5% taken out just by utilizing their knowledge and expertise. But let me reiterate, it is okay so long as the value outweighs the expectation.
Understand the TRUE cost of financial advice. Even as I write this, I can hear people saying that I understand 3.5% seems a little high but hey, it’s only 3.5%. It does seem like a small amount until you look at it for what it really is, a percentage of what you make and NOT a percentage of what you have. A couple came in for a portfolio review, an objective diagnostic analysis that they paid a nominal fee to make sure the advice they were given will get them exactly where they want to go without any surprises. Upon review we uncovered something we normally see with people who go see the financial advisor who charges a fee to help them manage their accounts. They were paying almost 2% for a 3.5% rate of return. Now at first mention of this to them, they did not seem to mind which frankly inspired me to write this article. I simply wrote this on the white board behind me… they are charging you $2,000 to make $3,500 for a net profit of $1,500 so your actual rate of return for the year was 1.5%. And they too, seemed undaunted by this. So I went back to the drawing board and wrote 57%. This got their attention, “What’s that?” How much they are charging you for your profit. You take all of the market risk, they take most of your profit.
Now as a Tax Strategist, I feel a certain affinity to talk about my favorite subject, taxes. More importantly how to avoid overpaying our IRS. This is a seldom discussed topic in financial firm conference rooms, but I believe when not planned for, taxes can truly bring the biggest harm to anyone’s portfolio, especially when considering Rollover IRAs. Mindful facts about qualified money, we all understand that assets grow TAX DEFERRED… so not only is your assets growing but so is the amount of taxes. Income is taxed at your marginal tax rate for both federal and state when it is distributed from the Rollover IRA and not to mention, if you tap into before 59 ½ there is an additional 10% penalty; and it becomes mandatory to distribute at an increasing rate once you hit 70 ½.
Utilizing Your Tax Losses for Your IRA
There are three tax classes of investments: Taxable (PayGo); Tax Deferred; and Tax Free. A good tax plan can utilize each tax class of investments to help the other all in order to create better opportunity for guaranteed capital growth and reduce taxes immediately and for the long term. Projecting income would highlight timing of certain strategies such as tax loss harvesting; tax advantaged investments; or investments that allow a built in capital loss with tax efficient income. With proven tactics, you can pay off your future tax obligations with minimum out of pocket assets thus increasing your cash flow analysis and funded ratio.
Simply put, plan your retirement to be in control of the income you receive and the taxes you will have to pay. We know (pretty much) what taxes are going to be next year and possibly the year after that; however, the future of the revenues needed to fulfill our unfunded liabilities of our Treasury Department and the strength of our dollar may well increase the effective rate of our annual tax obligation. It is important to fully understand how controlling your income can help the rest of your financial decisions. So the time to act is now when putting together a blue print of how you are going to be taxed throughout your retirement.
Diversification is not exclusive to a proper asset allocation, it should be employed during your accumulation phase in order to maximize net income throughout retirement. Understand how income from investments proliferates all areas of your annual taxes that may ultimately produce:
 Higher SSI taxable amount
 Higher marginal tax bracket
 Higher effective tax (through loss of deductions and tax credits)
 Higher Obamacare Tax, AMT and Cap Gains
Part of financial tax planning limits the risk of too much taxable income. Instead, proactive tax strategies identifies other areas in your balance sheet to maximize your funded ratio (assets to future obligation).
Ultimate Goal through Retirement
Basic formula for a successful business: Asset Base – Income – Lifestyle – Protection
The Asset Base as depicted by your balance sheet and financial statement, should be as diverse as it is deep. The strength of any business or retirement plan is dependent on the integrity and sustainability of its resources. It is from the diversity of assets where you can arrange a harmony of income and from the depth of capital to sustain your lifestyle. Comprehensive planning conclusively adds the layer of protection for predictable growth necessary for successful retirement.
Going to the Doctor’s Office – I feel find but a little sluggish and I don’t know why?
As with patient, it is necessary to perform unbiased and objective Diagnostic Testing: What you own (how it’s owned), capital appreciation and loss, 3 types of Income and 4 variations of Risk (market, inflation, opportunity and unforeseen) in order to answer: What do You Want? Are you on the right path to get there? Any surprises? What should you expect?
People spend more time planning their vacation than they do planning their finances.
I would like to think the Certified Planners Association is wrong here. A diagnostic stress test performed on your balance sheet (assets vs liabilities) and financial statement (cash flow analysis: income vs expense) should reveal the minimum: sustainability of assets, future obligations, funded ratio, income projections, net growth rate of capital needed, opportunities for improvement and predictability of continuous net worth.
We offer a comprehensive Financial and Tax Planning Blueprint for a one-time flat fee. We will walk you through our proven process to stress test your current portfolio of assets. You will receive a report detailing every aspect of your portfolio and deliver review and analysis. 30 day Money Back Guarantee if you are not 100% satisfied with your Financial and Tax Planning Blueprint.