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LAS VEGAS — College is a big expense for many families, but a paying strategy can result in significant tax savings, according to a college finance expert.
“Distribution planning isn’t just for retirement,” said certified financial planner Ross Riskin, chief learning officer of the Investments & Wealth Institute. Families also needed a plan if they were going to use their wealth to fund their college education, he said.
Funding education can be complicated, especially when juggling eligibility for college tax credits, Riskin said Monday at the American Institute of Certified Public Accountants’ annual conference in Las Vegas.
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The American Opportunity Tax Credit offers a maximum of $2,500 per undergraduate student for up to four years, and the Lifelong Learning Credit extends to college and professional degrees up to $2,000 per eligible student per year .
However, you can’t “double use” tax breaks by claiming one of these credits and withdrawing money from a 529 college savings plan for the same expenses. So, to take advantage of the full value of the credit, you must plan ahead to cover some of the tuition fees through revenue, loans, or other eligible sources.
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“What you’re paying doesn’t reflect the cost,” said Riskin, who is also a chartered accountant. For example, let’s say you’re considering three ways to cover $30,000 in college expenses: your cash flow, a 529 plan, or a student loan.
If your effective tax rate is 35% and you’re paying for college with $30,000 after taxes, it’s actually costing you $46,000, he said. You can also avail a 529 plan, which has grown from $18,000 in contributions, for example, and allows for tax-free withdrawals on eligible expenses.
What you pay is not what it costs you.
Ross Riskin
Chief Learning Officer of the Investments & Wealth Institute
While taking out a student loan might seem counterintuitive, the strategy potentially offers tax-free loan forgiveness for certain prospective nonprofit and government employees. In addition, student loans can provide other benefits, such as the ability to claim the US Opportunity Tax Credit or receive a credit for the student, Riskin said.
“Advisors have done themselves a disservice by trying to simplify it,” he said, noting that many families default to 529 withdrawals without analyzing other options.
How to weigh 529 plan withdrawals
With 529 plans, there is also a choice of whether to spend the money now or save it for family members, such as other children or even grandchildren, Riskin said. (Starting in 2024, a law change will allow families to transfer qualifying idle funds to a Roth IRA with restrictions.)
While the Secure Act included qualifying expenses in education for federal tax purposes, some states do not recognize these expenses for state tax purposes. For example, New York’s K-12 education is not a qualifying educational output.
If your withdrawal exceeds your qualifying spend or you withdraw funds after the year in which the spend was incurred, you may be required to pay additional taxes and a penalty. There is also a risk that the state will recoup state tax deductions previously received for contributions. “The recapture part is important,” Riskin said.
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