A 529 Plan Savings Strategy for Current College Expenses

For those individuals who are saving for their children’s or grandchildren’s education, one of the best methods is to contribute to a 529 plan.  Each state has their own plan and New York’s plan is one of the better ones as far as fees and investments offered https://www.nysaves.com.   The investment are provided through Vanguard and there are age based portfolios that lower the risk in the portfolio as the child gets closer to going to college or you can build your own portfolio using Vanguard funds.  As long as the funds are used for qualified education expenses there are no taxes paid on income or gains in the account.  If you are a New York State taxpayer and account owner, you may be entitled to a generous state income tax deduction of up to $5,000 ($10,000 for married couples filing jointly) on contributions to your account each year.

For individuals who have not contributed to a 529 plan but have a child attending college this year, there is a strategy that will at least allow you to take advantage of the $10,000 state income tax credit.  New York State only requires a 10 calendar day holding period for funds put into a 529 plan so a couple could contribute to an account in their name and within 10 days withdraw the money to pay for college expenses.  They would then qualify for the state tax credit for contributions up to $10,000.  For families with near-term college expenses, this 529 tax loophole can be a relatively easy way to lower their state income tax bill in the process of paying tuition, room and board, and other college-related costs.

For example, a family with a child attending school in the fall plans to pay all or a portion of tuition out of pocket.  Rather than paying the school directly, the family could add the funds to an existing or newly opened 529 account in the student’s name and then withdraws them shortly thereafter to cover the tuition payment.

But before implementing this strategy it is important to consider the following points.

• Expenses paid for by using a 529 plan are not eligible for federal tax breaks such as the American Opportunity Tax Credit or Lifetime Learning Credit.  These credits will reduce your federal tax liability which is likely to save you far more than you would save on your state taxes by paying for the same expenses using money added to a 529 plan.
• The state tax break is only for the year the 529 contribution is made. If you add money this year in anticipation of withdrawing it in early 2014, the tax break for your contribution will only apply to this year. If you have already hit your New York State 529 tax-deduction limit this year, you might want to wait until after Jan. 1, 2014 to contribute money you won’t need until then.
• Make sure to invest short-term 529 contributions safely.  Any money earmarked for upcoming college expenses should be invested in a cash-equivalent investment such as a money market offered by the plan. The last thing you want is for your tax-saving move to result in the loss of principal if the stock market happens to take a dip while your funds are invested in the 529.
• Finally, make sure you use the self-direct option versus using a broker for the 529 plan to limit any expenses associated with the plan.