Reader question: My husband and I will be taking our Required Minimum Distribution (RMD) from our IRAs for the 1st time this year and were planning to set up 529 accounts for our 6 grandchildren. So long as the amounts do not go over the gift limit for each child, is there any other thing we should be aware of? A.P.
Answer: I applaud you for setting up 529 college saving plans for your grandchildren. I cannot think of a better gift from a grandparent than the gift of an education! It’s a gift that will last a lifetime and one that they will surely associate fondly with you. Here are a number of key issues related to the 529 college savings plan:
· The annual gift limit for this year is $14,000 to as many people as you choose. You and your husband can join in giving therefore increasing your 2013 maximum to $28,000 for each grandchild. What’s more, the law allows you to give up to five years’ worth of gifts in a single year…meaning that you can accelerate the next four years’ worth of gifts into this year for a total limit of $140,000 per grandchild! Wow! That’s a total of $840,000 in all for six grandchildren! Ok, I’m guessing you weren’t thinking of giving these amounts!
Tip: If you have a taxable estate, annual gifts to a 529 plan for grandchildren is a great way to move money out of your estate but to a place where it is sheltered from taxes, out of their control and will ultimately be used for education expenses.
· If Alabama is your state of residence, you’ll receive an income tax deduction for up to $10,000 of contributions for joint tax filers ($5,000 for single filers) into the Alabama 529 plan each calendar year which could save you about $500 per year.
Tip: If you are thinking of investing more than $10,000 into a plan this year, considering investing only $10,000 this year and the balance early next year so as to maximize your State of Alabama income tax deduction. This is also true if you plan to transfer funds from another states’ plan into the Alabama 529 plan.
· As the donor, you can retain control over the 529 account and therefore make certain the funds are used for education expenses according to your wishes. Or you can have the parents of your grandchildren be the owners of the accounts and they will be in control.
Tip: If one grandchild does not go to college or doesn’t spend all the money in their 529 account, you can shift his or her funds to another grandchild.
· While you don’t get a federal income tax deduction for contributions to a 529 plan, once invested the money grows tax deferred and when used for qualified education expenses, distributions are tax free. Note that the definition of qualified education expenses is very broad and includes such things as tuition, room & board, books, and computers if required.
· There are a variety of investment options available to you. While you can pick and choose among over twenty mutual funds, we often see folks choose one of the ‘age-based’ portfolios. The professional managers for these portfolios automatically ‘adjust’ the allocation between stocks and bonds making the portfolio more conservative as the beneficiary (grandchild) approaches college age.
Tip: The Vanguard investment options offer the least expensive options.
· Any unused funds can be withdrawn by the account owner. Withdrawals for other than qualified education expenses are subject to ordinary income taxes on investment gains plus a ten percent federal penalty.
Tip: The benefits of tax deferral over a decade or more will likely more than offset the 10% federal penalty on non-qualified withdrawals so if you happen to ‘overfund’ a 529 plan it’s still a great investment.
For more information, visit www.CollegeCounts529.com.
Reader Question: You have explained how the charitable contribution under the Alabama Accountability Act is handled on our state tax return but how is a AAA contribution handled on our federal tax return? J.A.
Answer: You get an income tax credit on your Alabama tax return and a charitable income tax deduction on your federal income tax return but since your State of Alabama income taxes have been reduced by the full contribution (the tax credit), this ends up as a ‘wash’ for federal income tax purposes. The one exception is that if you are subject to the Alternative Minimum Tax, you will likely receive a net federal income tax benefit of up to $2,100. For more information on how to receive your tax credit visit www.AlabamaKids.net.