September 12th, 2018
It seems like it was just yesterday that you were watching your little one start kindergarten, full of dreams and excitement. Back then you thought you had all the time in the world before talks of college became reality.
Now, it feels like you blinked your eyes and here you are, with a child either in college or about to start college.
There are few people who have saved enough money to cover 100% of college expenses. Some have set aside some funds for college, whether in a separate account or co-mingled with other assets. Others will rely on financial aid, scholarships or loans.
Many believe that they won't qualify for financial aid or that there will be no benefit to them for saving in a separate account. However, even for those who have not made any prior financial preparations, there are still ways to use the 529 plan to maximize funds which can be contributed to covering the costs of education.
Let’s use Johnny as an example. Johnny is now a senior in high school, graduating in 2019. Johnny lives in New York and his parents have not set aside any funds for college. They are anticipating that his college costs will be $20,000 per year, after financial aid and scholarships are applied. They can afford to save $10,000 per year (approx. $192 per week) and earmark it for college.
Let’s look at one strategy:
Save $10,000 into the NYS 529 plan (nysaves.org) for the next 6 years (2018-2023). This will give Johnny $10,000 * 6 = $60,000 for college expenses.
New York State gives a deduction on the NYS tax return for contributions to 529 plans (for married couples filing joint tax returns, the maximum is $10,000 and for single tax filers the maximum is $5,000). Johnny’s parents can deduct their $10,000 each year (2018-2023) and save about $800 in NY income taxes each year. They now have an additional $800 * 6 = $4,800 to potentially use for college expenses. This saving should be set aside in a bank account earmarked for Johnny’s college expenses.
Appreciation within the 529 depends upon the investments selected and market returns. The additional earnings would be tax-free as long as the funds are used for college.
Summary: Johnny has $60,000 + $4,800 = $64,800 in savings (assuming no appreciation) and his college costs are $20,000 * 4 = $80,000 (ignoring the effects of inflation), therefore his shortfall is $80,000 - $64,800 = $15,200 or $3,800 per year. This could be funded by Johnny getting a part-time job or by applying for college loans.
Now let's take a look at another example:
Suzie will be a senior in college, graduating in 2019. Suzie's parents have no funds in a 529 plan and are now in a position to help pay for the last year of college. Suzie and her parents live in New York State. Similar to the previous example, her parents can make a contribution of $10,000 to a 529 plan in 2018 and then use those funds to pay $10,000 of Suzie's tuition bill for her fall semester. Then at the beginning of January 2019, they can make a contribution of $10,000 to the 529 plan and then use those funds to pay $10,000 of Suzie's tuition bill for her spring semester.
Timing is very important in this instance, as you must take your 529 plan distribution in the calendar year that you pay the corresponding expenses, and you must make your contribution in the calendar year for which you can then take the NYS deduction. In addition, Suzie's school must allow for the final semester's tuition to be paid after December 31st of the preceding year.
Assuming Suzie’s parents are in the 8% NYS tax bracket, they would save $800 on their 2018 NYS taxes and another $800 on their 2019 NYS taxes. This simple strategy can save them $1,600!
For New York City residents in the top marginal bracket, the annual tax savings when a married couple contributes $10,000 to a 529 plan is about $1,200 per year. And this is not just available for New York residents. A number of other states give a tax deduction or credit when a contribution is made to a 529 plan.
Bottom line, setting aside funds to cover the costs of college does not need to start at birth. Tax planning strategies that can enable you to maximize your financial resources are available even in the last year of school. Please give us a call if you would like help determining appropriate strategies that make sense for you.