How many 529 plans should I have?

[Like2Plan]

Link to college cost calculator from the College Board

[Like2Plan]

I did not understand this to be true... if it is true I might change my stance on 529s. More to follow soon.

Jim,
The 529 solves so many problems associated with saving for college. If I could write poetry, I would write "Ode to 529 Plan"

[jIM_Ohio]

The interpretation of a few I bounced this off on a tax board is

a) you could pay for 100 percent of tuition with a 529 plan
OR
b) you could choose to pay taxes on the withdraw (distribution) to claim a tax credit. This might mean pay $700 in taxes to get a credit of $2000.

Not one person suggested the contributions can be used to pay for qualified expenses and qualify for the credits.

[noppenbd]

The interpretation of a few I bounced this off on a tax board is

a) you could pay for 100 percent of tuition with a 529 plan
OR
b) you could choose to pay taxes on the withdraw (distribution) to claim a tax credit. This might mean pay $700 in taxes to get a credit of $2000.

Not one person suggested the contributions can be used to pay for qualified expenses and qualify for the credits.

If you look at the IRS example (page 50 of Pub 970), and change some of the inputs I think you can get the credit and still have a mostly tax-free withdrawal (not 100% though). From the IRS example, with inputs changed:

Total qualified education expenses $10,000
Minus: Tax-free educational assistance -0
Minus: Expenses taken into account in figuring Hope credit -2,200
Equals: Adjusted qualified
education expenses (AQEE) $7,800

(The example assumes a $3700 529 withdrawal, of which $1200 is earnings. Let's assume we take out $10,000 less the expected $1650 Hope credit, which equals $8350, of which $2700 is earnings)

The taxable part of the distribution is figured as follows.

1. $2,700 (earnings) × $7,800 AQEE / $8,350 distribution
=$2,522 (tax-free earnings)
2. $2,700 (earnings)-$2,522 (tax-free earnings)
=$178 (taxable earnings)

So on a $8,350 withdrawal, only $178 is taxable, and you can still take the full Hope credit.

LL credit is 20% of 10K expenses, so you would not be able to do this for after the first two years of college. Maybe the best plan is to aim for 2 years of college fully paid for through 529, and the rest either borrowed or paid with after-tax monies or IRA withdrawals.

[jIM_Ohio]

If you look at the IRS example (page 50 of Pub 970), and change some of the inputs I think you can get the credit and still have a mostly tax-free withdrawal (not 100% though). From the IRS example, with inputs changed:

Total qualified education expenses $10,000
Minus: Tax-free educational assistance -0
Minus: Expenses taken into account in figuring Hope credit -2,200
Equals: Adjusted qualified
education expenses (AQEE) $7,800

(The example assumes a $3700 529 withdrawal, of which $1200 is earnings. Let's assume we take out $10,000 less the expected $1650 Hope credit, which equals $8350, of which $2700 is earnings)

The taxable part of the distribution is figured as follows.

1. $2,700 (earnings) × $7,800 AQEE / $8,350 distribution
=$2,522 (tax-free earnings)
2. $2,700 (earnings)-$2,522 (tax-free earnings)
=$178 (taxable earnings)

So on a $8,350 withdrawal, only $178 is taxable, and you can still take the full Hope credit.

LL credit is 20% of 10K expenses, so you would not be able to do this for after the first two years of college. Maybe the best plan is to aim for 2 years of college fully paid for through 529, and the rest either borrowed or paid with after-tax monies or IRA withdrawals.

I agree with all of above.

especially portion repeated below

LL credit is 20% of 10K expenses, so you would not be able to do this for after the first two years of college. Maybe the best plan is to aim for 2 years of college fully paid for through 529, and the rest either borrowed or paid with after-tax monies or IRA withdrawals.

Remember that the whole premise of my approach is
a) fully fund all retirement obligations (fully fund means make sure retirement plan is on track, not to max out every account).
b) try to capture savings at federal tax level for education benefits while funding as much education as is reasonable.

The main problem with this is education planning is only 18 years duration per person. If a person is not "planning" on retiring until around 4-5 years after their kid finishes HS or 4-5 years after they finish college, we are dealing with a possible 28 year time horizon for retirement planning. It is tough to project anything concrete with retirement planning 28 years out- best bet is then to max the retirement contributions and get all current tax deductions NOW (assuming 25% bracket) and focus on education savings once the 401k and IRAs are maxed out.

If a person does this for 10 years (maxes 401k and IRA) they have 8 years to college and 18 years to retirement, with a solid retirement foundation... they could decrease a 401k or IRA contribution to get a 529 plan started (8 years out) and deal with more short term tax planning issues.

[Like2Plan]

The interpretation of a few I bounced this off on a tax board is

a) you could pay for 100 percent of tuition with a 529 plan
OR
b) you could choose to pay taxes on the withdraw (distribution) to claim a tax credit. This might mean pay $700 in taxes to get a credit of $2000.

Not one person suggested the contributions can be used to pay for qualified expenses and qualify for the credits.

Jim,
There are two components to every 529 distribution:
1. The basis (the original investment) and the
2. Earnings.

This is much like a non-deductable IRA: although in a non-deductable IRA, the earnings grow tax deferred instead of tax free. (When funds are pulled out of these accounts the original contribution is not taxed--although the IRS does put their spin on things when you have more than one type of IRA... But, that is a different topic... )

As with anything dealing with the IRS, there is no simple way to do things.

Pub 970 Page 49 TIP states:Even if a QTP is used to finance a student's education, the student, or the student's parents still may be eligible to claim either the Hope credit or the lifetime learning credit.
On page 50, there is an example.
Let's model another example--this is how I see it:
On the 1098-T 2007 (tuition statement)
Box 2. 11,000 (shows the amount billed for qualified tuition and fees)
(This is the student's 2nd year)

Hope credit is taken using the basis of 2,200 (directions say use qualified expenses, but not more than 2,200). Hope credit = $1650.

QTP distribution=19,000.00
Total qualified education expenses: 19,000. (Includes tuition and fees, room and board and books)

1099-Q 2007
shows
box 1. (gross distribution ) 19,000
box 2 (earnings) 6,575
box 3 Basis 12,425.
box 5. State box checked.

Total qualified educational expenses: 19,000.00
minus expenses taken into account for Hope: 2,200.00
Adjusted Qualified Educational Expenses (AQEE): 16,800.00

6575 (earnings) X ( 16,800 (AQEE) / 19,000 (distribution)) = $5814 (tax free earnings)

6575-5814= 761 in taxable earnings (for the child to include on line 21 of 1040)

Result: Parents get a tax credit of $1650, child pays taxes on $761 ( and no 10% penalty--see form 5329 Additional Tax on Certain Distributions From Education Accounts. This tax does not apply to distributions that are includible in income if you used the qualified education expenses to figure the Hope and lifetime learning credit).

If using the LLC instead of Hope, the basis for the credit would be 10,000 (for a 2,000 credit). So, the results would not be as good.
6575 X (9,000/19,000) = $3224 (tax free)
$3351 would be taxed on the child's return. It would still be an overall win even if the kid was in the 33% tax bracket.

Publication 525 (2007), Taxable and Nontaxable Income other income
Qualified tuition program (QTP). A qualified tuition program (also known as a 529 program) is a program set up to allow you to either prepay or contribute to an account established for paying a student's qualified higher education expenses at an eligible educational institution. A program can be established and maintained by a state, an agency or instrumentality of a state, or an eligible educational institution.
The part of a distribution representing the amount paid or contributed to a QTP is not included in income. This is a return of the investment in the program.
The beneficiary generally does not include in income any earnings distributed from a QTP if the total distribution is less than or equal to adjusted qualified higher education expenses. See Publication 970 for more information.

Here is another example:

The Best Way to Save for College

[Like2Plan]

noppenbd,
You were way faster than I was with the math.

[Like2Plan]

If a person does this for 10 years (maxes 401k and IRA) they have 8 years to college and 18 years to retirement, with a solid retirement foundation... they could decrease a 401k or IRA contribution to get a 529 plan started (8 years out) and deal with more short term tax planning issues.

I don't like to see reductions in funding to 401k/IRAs. But, assuming all 3 could not be funded to the max all at the same time, doing it the way you suggest would allow to stockpile funds in the 529 plan to help take care of the short term cash flow issues when its time to go off to college. Also, there is no rule you have to have 100% of the money by the time the child reaches age 18 (although it is trickier when there is more than one to plan for).

We are still making contributions to the 529 plans at the same level that we always have even though DS is in college. Part of the reason it gives us a longer time horizon. We also figured it would be an advantage so as not to overcontribute because we have a better idea as to exact dollar figures... (Some 529 plans do have restrictions on how long the money has to be in the account before you can withdraw, it's a good idea to be familiar with your state's plan. )

[jIM_Ohio]

L2P- I have read the example several times.

Please realize there is a second sentence which follows this in pub 970

Even if a QTP is used to finance a student's education, the student, or the student's parents still may be eligible to claim either the Hope credit or the lifetime learning credit.

The whole paragraph reads

A Hope or lifetime learning credit (education credit) can be claimed in the same year the beneficiary takes a tax-free distribution from a QTP, as long as the same expenses are not used for both benefits. This means that after the beneficiary reduces qualified education expenses by tax-free
educational assistance, he or she must further reduce
them by the expenses taken into account in determining
the credit.

This was the math you showed in

6575 (earnings) X ( 16,800 (AQEE) / 19,000 (distribution)) = $5814 (tax free earnings)

6575-5814= 761 in taxable earnings (for the child to include on line 21 of 1040)

FYI $2200 is needed for Hope of $1650 because hope is a credit for
100% of first $1100
50% of next $1100
which is $1650 total

(you post suggested some confusion when I read it back to myself- if you understood this, my bad).

What you are doing (or the math is doing) is making a portion of 529 taxable to claim a credit against it and get a larger refund.

I am saying you cannot take a 100% taxfree distribution from 529 and claim a credit.
I am saying a portion of the withdraw can be taxed to get the credit.

You also made a statement which is very important:

We also figured it would be an advantage so as not to overcontribute because we have a better idea as to exact dollar figures...

There are many 529 restrictions. The biggest of which is money has to be used for TUITION and related expenses for education to be a qualified distribtion.

If the distribution does not qualify, you lose 10% of it.
If you oversave, you lose 10% as well.

Yet more than likely the account will not be making 10% annual gains or saving you 10% in taxes, so is the account really worth it?

Fewer restrictions on IRAs (IMO).
Tax planning is nearly impossible to do 2-4 years out... so even 8 years of "tax planning" as I suggested is shooting for the stars.

This also means if you have a deduction which would save you 25% NOW, it would be tough to pass that deduction up for a possible tax savings later... there are few places in tax code you could get 25% back.

[Like2Plan]

L2P- I have read the example several times.

Please realize there is a second sentence which follows this in pub 970



The whole paragraph reads

Quote:
A Hope or lifetime learning credit (education credit) can be claimed in the same year the beneficiary takes a tax-free distribution from a QTP, as long as the same expenses are not used for both benefits. This means that after the beneficiary reduces qualified education expenses by tax-free
educational assistance, he or she must further reduce them by the expenses taken into account in determining
the credit.

.

jIM,
This is repeated over and over in the pub 970 and on the forms. You may not take a Hope and a Lifetime Learning credit at the same time.

The tip says: "Even if a QTP is used to finance a student's education, the student or the student's parents still may be eligible to claim either the Hope credit or the lifetime learning credit. "

Are you interpreting this another way?

[Like2Plan]

This was the math you showed in

This was the math you showed in
Quote:
6575 (earnings) X ( 16,800 (AQEE) / 19,000 (distribution)) = $5814 (tax free earnings)

6575-5814= 761 in taxable earnings (for the child to include on line 21 of 1040)

FYI $2200 is needed for Hope of $1650 because hope is a credit for
100% of first $1100
50% of next $1100
which is $1650 total

Jim,
You must have missed this part in my example:
Total qualified educational expenses: 19,000.00
minus expenses taken into account for Hope: 2,200.00
Adjusted Qualified Educational Expenses (AQEE): 16,800.00

6575 (earnings) X ( 16,800 (AQEE) / 19,000 (distribution)) = $5814 (tax free earnings)

6575-5814= 761 in taxable earnings (for the child to include on line 21 of 1040)

[Like2Plan]

There are many 529 restrictions. The biggest of which is money has to be used for TUITION and related expenses for education to be a qualified distribtion.

Just a clarification, here.

Qualified education expenses. These expenses are the amounts paid for tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution (defined in the next column).

They also include the reasonable costs of room and board for a designated beneficiary who is at least a half-time student. The cost of 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.

The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.
Link 8. Qualified Tuition Program (QTP)

If the distribution does not qualify, you lose 10% of it.
If you oversave, you lose 10% as well.
Yet more than likely the account will not be making 10% annual gains or saving you 10% in taxes, so is the account really worth it?

Jim,
Again, just to clarify--you do not lose 10%. You lose 10% of the earnings only.

[Like2Plan]

What you are doing (or the math is doing) is making a portion of 529 taxable to claim a credit against it and get a larger refund.

I am saying you cannot take a 100% taxfree distribution from 529 and claim a credit.
I am saying a portion of the withdraw can be taxed to get the credit.
.

We are saying the same thing. Although, to clarify--the beneficary getS taxed. Hopefully, they are in a lower tax bracket...

[Like2Plan]

Fewer restrictions on IRAs (IMO).

We are going to have to disagree on this one.

Tax planning is nearly impossible to do 2-4 years out... so even 8 years of "tax planning" as I suggested is shooting for the stars.

No disagreements on this. Tax law from my perspective (a regular citizen) seems to be constantly changing

This also means if you have a deduction which would save you 25% NOW, it would be tough to pass that deduction up for a possible tax savings later... there are few places in tax code you could get 25% back .

Jim,
That 25% now, could mean 33% (or more later) especially if you are talking long time horizons. Most people are cynical and believe taxes are going to go up. (Put me in that category). Plus, you don't know the big bucks you might be making in the next 20 years even if tax rates stayed the same.

[jIM_Ohio]

Fewer restrictions on IRAs (IMO).

We are going to have to disagree on this one.

IRAs have 72t rule which allows distributions for any reason without exception (if distributions are substantially equal).
Plus education
Plus health care
Plus first time house
Plus contributions (if a Roth)

I see no such flexibility with 529's (education only).

Jim,
That 25% now, could mean 33% (or more later) especially if you are talking long time horizons. Most people are cynical and believe taxes are going to go up. (Put me in that category). Plus, you don't know the big bucks you might be making in the next 20 years even if tax rates stayed the same.

Tax brackets existed in the past and my planning anticipates the brackets will exist in the future. This contitutes 2 assumptions- the percentages on the brackets and the ranges of incomes the brackets cover. Every year since I have looked the brackets adjust upward for inflation.

To go from one bracket to another now, a person generally needs to double their income. I could not see that happening over an 8 year period for me. Even 16 years would be pushing it. So my risk is the percentage of the bracket and any increase to 15% bracket is "taxing the poor" more than "taxing the rich". I will take my chances.