Tax Saving Moves for 2020

Tax Saving Moves for 2020

As we approach the end year, we share our list of tax-saving moves for 2020. 2020 has been a challenging and eventful year. The global coronavirus outbreak changed the course of modern history. The Pandemic affected many families and small businesses. The stock market crashed in March, and It had a full recovery in just a few months.

With so many changes, now is a great time to review your finances. You can make a few smart and simple tax moves that can lower your tax bill and increase your tax refund.

Whether you file taxes yourself or hire a CPA, it is always better to be proactive. If you expect a large tax bill or your financials have changed substantially, talk to your CPA. Start the conversation today. Don’t wait until the last moment. Being ahead of the curve will help you make well-informed decisions without the stress of tax deadlines.

1. Know your tax bracket

The first step of mastering your taxes is knowing your tax bracket. 2020 is the third year after the TCJA took effect. One of the most significant changes in the tax code was introducing new tax brackets.

Here are the tax bracket and rates for 2020.

Tax Brackets 2020

2. Decide to itemize or use a standard deduction

Another recent change in the tax law was the increase in the standard deduction. The standard deduction is a specific dollar amount that allows you to reduce your taxable income. As a result of this change, nearly 90% of all tax filers will take the standard deduction instead of itemizing. It makes the process a lot simpler for many Americans. Here are the values for 2020:

Filing status 2020 tax year
Single $12,400
Married, filing jointly $24,800
Married, filing separately $12,400
Head of household $18,650

3. Maximize your retirement contributions

You can save taxes by contributing to a retirement plan. Most contributions to qualified retirement plans are tax-deductible and will lower your tax bill.

  • For employees – 401k, 403b, 457, and TSP. The maximum contribution to qualified employee retirement plans for 2020 is $19,500. If you are at the age of 50 or older, you can contribute an additional $6,500.
  • For business owners – SEP IRA, Solo 401k, and Defined Benefit Plan. Business owners can contribute to SEP IRA, Solo 401k, and Defined Benefit Plans to maximize your retirement savings and lower your tax bill. The maximum contribution to SEP-IRA and Solo 401k in 2020 is $57,000 or $63,500 if you are 50 and older.

If you own SEP IRA, you can contribute up to 25% of your business wages.

In a solo 401k plan, you can contribute as both an employee and an employer. The employee contribution is subject to a $19,500 limit plus a $6,500 catch-up. The employer match is limited to 25% of your compensation for a maximum of $37,500. In many cases, the solo 401k plan can allow you to save more than SEP IRA.

Defined Benefit Plans is an option for high-income earners who want to save more aggressively for retirement above the SEP-IRA and 401k limits. The DB plan uses actuary rules to calculate your annual contribution limits based on your age and compensation. All contributions to your defined benefit plan are tax-deductible, and the earnings grow tax-free.

4. Convert to Roth IRA

Transferring investments from a Traditional IRA or 401k plan to a Roth IRA is known as Roth Conversion. It allows you to switch from tax-deferred to tax-exempt retirement savings.

The conversion amount is taxable for income purposes. The good news is that even though you will pay more taxes in the current year, the conversion may save you a lot more money in the long run.

If you believe that your taxes will go up in the future, Roth Conversion could be a very effective way to manage your future taxes. 

5. Contribute to a 529 plan

The 529 plan is a tax-advantaged state-sponsored investment plan, allowing parents to save for their children’s future college expenses. 529 plan works similarly to the Roth IRA. You make post-tax contributions. Your investment earnings grow free from federal and state income tax if you use them to pay for qualified educational expenses. Compared to a regular brokerage account, the 529 plan has a distinct tax advantage as you will never pay taxes on your dividends and capital gains.

Over 30 states offer a full or partial tax deduction or a credit on your 529 contributions. You can find the full list here. If you live in any of these states, your 529 contributions can significantly lower your state tax bill.

6. Make a donation

Donations to charities, churches, and various non-profit organizations are tax-deductible. You can support your favorite cause by giving back and lower your tax bill at the same time.

However, due to the new tax code changes, donations are tax-deductible only when you itemize your tax return. If you make small contributions throughout the year, you will be better off taking the standard deduction.

If itemizing your taxes is crucial for you, you might want to consolidate your donations in one calendar year. So, instead of making multiple charitable contributions over the years, you can give one large donation every few years.

7. Sell losing investments

2020 has been turbulent for the stock market. If you are holding stocks and other investments that dropped significantly in 2020, you can consider selling them. The process of selling losing investments to reduce your tax liability is known as tax-loss harvesting. It works for capital assets held outside retirement accounts (401k, Traditional IRA, and Roth IRA). Capital assets may include real estate, cars, gold, stocks, bonds, and any investment property, not for personal use.

The IRS allows you to use capital losses to offset capital gains. If your capital losses are higher than your capital gains, you can deduct the difference as a loss on your tax return. This loss is limited to $3,000 per year or $1,500 if married and filing a separate return.

8. Prioritize long-term over short-term capital gains

Another way to lower your tax bill when selling assets is to prioritize long-term over short-term capital gains. The current tax code benefits investors who keep their assets for more than one calendar year. Long-term investors receive a preferential tax rate on their gains. While investors with short-term capital gains will pay taxes at their ordinary income tax level

Here are the long-term capital gain tax brackets for 2020:

Long-Term Capital Gains Tax Rate Single Filers (Taxable Income) Married Filing Separately
0% $0-$40,000 $0-$40,000
15% $40,000-$441,450 $40,000-$248,300
20% Over $441,550 Over $248,300

High-income earners will also pay an additional 3.8% net investment income tax.

9. Contribute to FSA and HSA

With healthcare costs always on the rise, you can use a Flexible Spending Account (FSA) or a Health Savings Account (HSA) to cover your medical bills and lower your tax bill.

Flexible Spending Account (FSA)

A Flexible Spending Account (FSA) is tax-advantaged savings account offered through your employer. The FSA allows you to save pre-tax dollars to cover medical and dental expenses for yourself and your dependents. The maximum contribution for 2020 is $2,750 per person. If you are married, your spouse can save another $2,750 for a total of $5,500 per family.  Some employers offer a matching FSA contribution for up to $500. Typically, it would help if you used your FSA savings by the end of the calendar year. However, the IRS allows you to carry over up to $500 balance into the new year.

Dependent Care FSA (CSFSA)

A Dependent Care FSA (CSFSA) is a pre-tax benefit account that you can use to pay for eligible dependent care services, such as preschool, summer day camp, before or after school programs, and child or adult daycare. It’s an easy way to reduce your tax bill while taking care of your children and loved ones while you continue to work. The maximum contribution limit for 2020 for an individual who is married but filing separately is $2,500. For married couples filing jointly or single parents filing as head of household, the limit is $5,000.

Health Savings Account (HSA)

A Health Savings Account (HSA) is an investment account for individuals under a High Deductible Health Plan (HDHP) that allows you to save money on a pre-tax basis to pay for eligible medical expenses. The qualified High Deductible Plan typically covers only preventive services before the deductible. To qualify for the HSA, the HDHP should have a minimum deductible of $1,400 for an individual and $2,800 for a family. Additionally, your HDHP must have an out-of-pocket maximum of up to $6,900 for one-person coverage or $13,800 for family.

The maximum contributions in HSA for 2020 are $3,550 for individual coverage and $7,100 for a family. HSA participants who are 55 or older can contribute an additional $1,000 as a catch-up contribution. Unlike the FSA, the HSA doesn’t have a spending limit, and you can carry over the savings in the next calendar year.

Keep in mind that the HSA has three distinct tax advantages. First, all HSA contributions are tax-deductible and will lower your tax bill. Second, you will not pay taxes on dividends, interest, and capital gains. Third, if you use the account for eligible expenses, you don’t pay taxes on those withdrawals.

10. Defer income

Is 2020 shaping to be a high income for you? Perhaps, you can defer some of your income from this calendar year into 2021 and beyond. This move will allow you to delay some of the income taxes coming with it. Even though it’s not always possible to defer wages, you might be able to postpone a large bonus, royalty, or one-time payment. Remember, it only makes sense to defer income if you expect to be in a lower tax bracket next year.

On the other hand, if you expect to be in a higher tax bracket tax year next year, you may consider taking as much income as possible in 2020.

11. Skip RMDs

Are you taking the required minimum distributions (RMD) from your IRA or 401k plan? The CARES Act allows retirees to skip their RMD in 2020. If you don’t need the extra income, you can skip your annual distribution. This move will lower your taxes for 2020 and may cut your future Medicare cost.

12. Receive employee retention tax credit for eligible businesses

The CARES Act granted employee retention credits for eligible businesses affected by the Coronavirus pandemic. The credit amount equals 50% of eligible employee wages paid by an eligible employer in a 2020 calendar quarter. The credit is subject to an overall wage cap of $10,000 per eligible employee.

Qualifying businesses must fall into one of two categories:

  • The employer’s business is fully or partially suspended by government order due to COVID-19 during the calendar quarter.
  • The employer’s gross receipts were below 50% of the comparable quarter in 2019. Once the employer’s gross receipts went above 80% of a comparable quarter in 2019, they no longer qualify after the end of that quarter.

 

12 End of Year Tax Saving Tips

end of year tax saving tips

As we approach the close of 2019, we share our list of 12 end of year tax saving tips. Now is a great time to review your finances. You can make several smart and simple tax moves that can help lower your tax bill and increase your tax refund.

The Tax Cuts and Jobs Act of 2017 made sweeping changes in the tax code that affected many families and small business owners. If the previous tax season caught you off-guard, now you have a chance to redeem yourself.

Whether you file taxes yourself or hire a CPA, it is always better to be proactive. If you are expecting a large tax bill or your financials have changed substantially since last year, talk to your CPA. Start the conversation. Don’t wait until the last moment. Being ahead of the curve will help you make well-informed decisions without the stress of tax deadlines.

1. Know your tax bracket

The first step of mastering your taxes is knowing your tax bracket. 2019 is the second year after the TCJA took effect. One of the most significant changes in the tax code was introducing new tax brackets.

Here are the tax bracket and rates for 2019.

End of Year Tax Tips

2. Decide to itemize or use a standard deduction

Another big change in the tax law was the increase in the standard deduction. The standard deduction is a specific dollar amount that allows you to reduce your taxable income. As a result of this change, nearly 90% of all tax filers will take the standard deduction instead of itemizing. It makes the process a lot simpler for many Americans. Here are the values for 2019:

End of Year Tax Tips

3. Maximize your retirement contributions

Most contributions to qualified retirement plans are tax-deductible and will lower your tax bill.

  • For employees – 401k, 403b, 457 and TSP. The maximum contribution to qualified employee retirement plans for 2019 is $19,000. If you are at the age of 50 or older, you can contribute an additional $6,000.
  • For business owners – SEP IRA, Solo 401k and Defined Benefit Plan. Business owners can contribute to SEP IRA, Solo 401k, and Defined Benefits plans to maximize your retirement savings and lower your tax bill. The maximum contribution to SEP-IRA and Solo 401k in 2019 is $56,000 or $62,000 if you are 50 and older.

If you own SEP IRA, you can contribute up 25% of your business wages.

In a solo 401k plan, you can contribute as both an employee and an employer. The employee contribution is subject to a $19,000 limit plus a $6,000 catch-up. The employer match is limited to 25% of your compensation for the maximum $37,000. Depending on how you pay yourself, sometimes solo 401k can allow you for more savings than SEP IRA.

Defined Benefit Plans is an option for high-income earners who want to save more aggressively for retirement above the SEP-IRA and 401k limits. The DB plan uses actuary rules to calculate your annual contribution limits based on your age and compensation. All contributions to your defined benefit plan are tax-deductible, and the earnings grow tax-free.

4. Convert to Roth IRA

The process of transferring assets from a Traditional IRA or 401k plan to a Roth IRA is known as Roth Conversion. It allows you to switch from tax-deferred to tax-exempt retirement savings. You can learn more about the benefits of Roth IRA here.

The conversion amount is taxable for income purposes. The good news is that even though you will pay higher taxes in the current year, it may save you a lot more money in the long run.

While individual circumstances may vary, Roth Conversion could be very effective in a year with low or no income. Talk to your accountant or financial advisor. Ask if Roth conversion makes sense for you.

5. Contribute to a 529 plan

The 529 plan is a tax-advantaged state-sponsored investment plan, which allows parents to save for their children’s future college expenses. 529 plan works similarly to the Roth IRA. You make post-tax contributions. Your investment earnings grow free from federal and state income tax if you use them to pay for qualified educational expenses. Compared to a regular brokerage account, the 529 plan has a distinct tax advantage as you will never pay taxes on your dividends and capital gains.

Over 30 states offer a full or partial tax deduction or a credit on your 529 contributions. You can find the full list here. If you live in any of these states, your 529 contributions can lower your state tax bill significantly.

6. Make a donation

Donations to charities, churches, and various non-profit organizations are tax-deductible. You can support your favorite cause by giving back and lower your tax bill at the same time.

However, due to the changes in the new tax code, donations are tax-deductible only when you itemize your tax return. If you make small contributions throughout the year, you probably will be better off taking the standard deduction.

If itemizing your taxes is crucial for you, then you might want to consolidate your donations in one calendar year. So, instead of making multiple charitable contributions over the years, you can give one large donation every few years.

7. Sell losing investments

The process of selling losing investments to reduce your tax liability is known as tax-loss harvesting. It works for capital assets held outside retirement accounts (such as 401k, Traditional IRA, and Roth IRA). Capital assets may include real estate, cars, gold, stocks, bonds, and any investment property, not for personal use.

The IRS allows you to use capital losses to offset capital gains. If your capital losses are higher than your capital gains, you can deduct the difference as a loss on your tax return. This loss is limited to $3,000 per year or $1,500 if married and filing a separate return.

8. Prioritize long-term over short-term capital gains

Another way to lower your tax bill when selling assets is to prioritize long-term over short-term capital gains. The current tax code benefits investors who keep their assets for more than one calendar year. Long-term investors receive a preferential tax rate on their gains. While investors with short-term capital gains will pay taxes at their ordinary income tax level

Here are the long-term capital gain tax brackets for 2019:

End of Year Tax Tips

High-income earners will also pay an additional 3.8% net investment income tax.

9. Take advantage of FSA and HSA

With healthcare costs always on the rise, you can use a Flexible Spending Account (FSA) or a Health Savings Account (HSA) to cover your medical bills and lower your tax bill.

Flexible Spending Account (FSA)

A Flexible Spending Account (FSA) is a tax-advantaged savings account offered through your employer. The FSA allows you to save pre-tax dollars to cover medical and dental expenses for yourself and your dependents. The maximum contribution for 2019 is $2,700 per person. If you are married, your spouse can save another $2,700 for a total of $5,400 per family. Typically, you should use your FSA savings by the end of the calendar year. However, the IRS allows you to carry over up to $500 balance into the new year.

Dependent Care FSA (CSFSA)

A Dependent Care FSA (CSFSA) is a pre-tax benefit account that you can use to pay for eligible dependent care services, such as preschool, summer day camp, before or after school programs, and child or adult daycare. It’s an easy way to reduce your tax bill while taking care of your children and loved ones while you continue to work. The maximum contribution limit for 2019 for an individual who is married but filing separately is $2,500. For married couples filing jointly or single parents filing as head of household, the limit is $5,000.

Health Savings Account (HSA)

A Health Savings Account (HSA) is an investment account for individuals under a High Deductible Health Plan (HDHP) that allows you to save money on a pre-tax basis to pay for eligible medical expenses.The qualified High Deductible Plan typically covers only preventive services before the deductible. To qualify for the HSA, the HDHP should have a minimum deductible of $1,350 for an individual and $2,700 for a family. Additionally, your HDHP must have an out-of-pocket maximum of up to $6,750 for one-person coverage or $13,500 for family.

The maximum contributions in HSA for 2019, are $3,500 for self-only coverage and $7,000 for a family. HSA participants who are 55 or older can contribute an additional $1,000 as a catch-up contribution. Unlike the FSA, the HSA doesn’t have a spending limit, and you can carry over the savings in the next calendar year.

Keep in mind that the HSA has three distinct tax advantages. First, all HSA contributions are tax-deductible and will lower your tax bill. Second, you will not pay taxes on dividends, interest, and capital gains. Third, if you use the account for eligible expenses, you don’t pay taxes on those withdrawals either.

10. Defer income

Deferring income from this calendar year into the next year will allow you to delay some of the income taxes coming with it. Even though it’s not always possible to defer wages, you might be able to postpone a large bonus, royalty, or onetime payment. Remember, it only makes sense to defer income if you expect to be in a lower tax bracket next year.

Reversely, if you are expecting to be in a higher tax bracket tax year next year, you may consider taking as much income as possible in this tax year.

11. Buy Municipal Bonds

Municipal bonds are issued by local governments, school districts, and authorities to fund local projects that will benefit the general public. The interest income from most municipal bonds is tax-free. Investors in these bonds are exempt from federal income tax. If you buy municipal bonds issued in the same state where you live, you will be exempt from state taxes as well.

12. Take advantage of the 199A Deduction for Business Owners

If you are a business owner or have a side business, you might be able to use the 20% deduction on qualified business income. The TCJA established a new tax deduction for small business owners of pass-through entities like LLCs, Partnerships, S-Corps, and sole-proprietors. While the spirit of the law is to support small business owners, the rules of using this deduction are quite complicated and restrictive. For more information, you can check the IRS page. In summary, qualified business income must be related to conducting business or trade within the United States or Puerto Rico. The tax code also separates the business entities by industry – Qualified trades or businesses and Specified service trades or businesses.

Qualified versus specified service trade

Specified service businesses include the following trades: Health (e.g., physicians, nurses, dentists, and other similar healthcare professionals), Law, Accounting, Actuarial science, Performing arts, Consulting, Athletics, and Financial Services. Qualified trades or businesses is everything else.

For “specified service business,” the deduction gets phased out between $315,000 and $415,000 for joint filers. For single filers, the phase-out range is $157,500 to $207,500.

The qualified trades and businesses are also subject to the same phaseout limits. However, if their income is above the threshold, the 199A deduction becomes the lesser of the 20% of qualified business income deduction or the greater of either 50 percent of the W-2 wages of the business, or the sum of 25% of the W-2 wages of the business and 2.5% of the unadjusted basis immediately after acquisition of all qualified property.

If this all sounds very complicated to you, it’s because it is complicated.Contact your accountant or tax adviser to see if you can take advantage of this deduction.

Solving the student debt crisis

Student Debt Growth

The looming student debt crisis

As a financial advisor working with many young families, I am regularly discussing college planning.  Many of my clients want to help their children with the constantly growing college tuition. Currently, the amount of US student debt is $1.56 trillion, spread among 45 million borrowers. By 2023, 40% of borrowers can default on their loans. I am not running for president, but I am very curious about the upcoming debate about fighting the upcoming student debt in America.

One recent proposal from the Republican party was to allow 529 plan participants to pay off student debt.

Another proposal from the presidential candidate Elizabeth Warren is to cancel student debt partially or entirely for households based on their income. Furthermore, many Democrat candidates signed for free public college for all.

While all these ideas have certain merits, I am not confident that they will solve the problem long-term. As a parent and married to my wife who is paying off student loans, I would like to share my opinion.  Here are some of my suggestions

Promote 529 plans

In one of my previous articles, I discussed the benefits of 529 plans. Sadly, only 30% of US families know about or use 529 plans. It’s really striking how little Americans know about this option. 529 plans are state-sponsored tax-advantaged investment accounts allowing parents and other family members to save for qualified college expenses. It literally takes 5-10 minutes to open a 529 account.

Make 529 contributions tax-deductible

Currently, 529 contributions are after taxes. The tax advantage comes from not paying taxes on any future capital gains if you use the funds to pay for eligible college expenses. Additionally, over 30 states offer full or partial state income tax deduction on 529 contributions.

I would like to go one step further and propose federal income tax deduction up to a certain annual limit (say $5,000 or $10,000) with a phaseout over certain household income level (call it $250,000). This income deduction will help low and middle-class families save for college without putting a massive strain on their budget.  

Expand the Employer-sponsored 529 plans

In reality, most US families do not use the 529 plan because they don’t know about them or are uncertain about their investment choices. One way to popularize the 529 plan is motivating employers to include them as part of their benefits package similar to 401k plans. Employees can set up automatic payroll deposits and make regular contributions to their 529 accounts. Unfortunately, according to a recent survey by Gradadvisor, only 7% of employers offer 529 plans through their benefits.

Currently, the employer 529 match is taxable income to the parent. At the end of the year, the parent must pay personal taxes on any amount received through their employer.

I believe this provision is discouraging a lot of people to participate in these plans. In order to encourage higher participation in employer-sponsored 529 plans., the employer match should not be treated as income to the parent if used for qualified educational expenses.

Promote more work-study grants and employer-sponsored scholarships

Many college graduates leave school unprepared for the real world. Sometimes, I feel that there is a disconnect between skills learned at school and those needed to compete in the work marketplace.

While many public and private schools are doing a great job in teaching students those skills, I think we can do much better by connecting the school programs with the business. Let’s face it. Unless you are from an Ivy League school, how many students have had the chance to speak to a corporate CEO, a successful small business owner or a community leader.

With US unemployment at a record low, many businesses are struggling to find qualified workers. If we can encourage schools and employers to work together and set up employer-sponsored scholarships, internship programs, and work-study grants, we will have a lot more students learning real-life skills, earn money while study and potentially come out with smaller or no student loans.

Have personal finance as a mandatory class in high school and college

Only 1/3 of states require a mandatory personal finance class in high school. And zero states mandate it in college. It may sound radical, but I believe that every high school and public college should require one personal finance class in the curriculum regardless of the student major.

Teaching kids and young adults essential financial skills like saving money, budgeting, and investing will help them make better choices later in life.

It also means that we need to find teachers who can coach personal finance. Unfortunately, finance and economics are mostly taught in business schools and largely ignored outside of the space. This is where connecting schools with local business leaders can be helpful.

Extend the Non-Taxable Loan Forgiveness

There are several Federal and State programs that offer Loan Forgiveness. However, in most cases, student loan forgiveness is treated as taxable income in the year when the loan was written off.  For some borrowers performing public service or working as teachers, lawyers and physicians in underserved areas, the loan forgiveness can be tax-free.

If your employer offers to pay off your student loans, you will receive a tax bill from the IRS. The amount of your forgiven loan will be added to your annual income and taxed as ordinary income. Knowing this tax trap, very few people opt for that option. If you can’t afford to pay off your student loan, what are the chances you can pay the taxes on the loan forgiveness?

Separately, being an elementary school teacher in a desirable area like Manhattan or San Francisco doesn’t make you financially better off than the rest of your colleagues. Most teachers can’t afford to live in San Francisco or Manhattan on a teacher’s salary, how do we expect them to pay off their loans.

Furthermore, non-taxable loan forgiveness should be designed to reward responsible borrowers who are paying off their loans regularly. I think a dollar to dollar match could encourage more people to pay off their loans.

What about loan cancellation

Canceling loans entirely or partially is a very admirable idea but it could turn into a double-edged sword. On one hand, it’s not completely fair to people who are diligently paying off their student loans month after month. And on the other hand, loan cancellation will encourage more people to take on student debt and not pay it. It might provide temporary relief, but it will not solve the problem long-term. I much rather find a way to empower and educate borrowers.

Improve student access to financial advice

How many parents or students speak to a financial advisor before taking a student loan? I bet a lot less than we hope for. Maybe it’s partially our fault as finance professionals but as a society, we need to find a way to get more financial advisors and colleges.

Before the TJCA of 2017, professional service expenses such as fees for CPAs and financial advisors were tax-deductible. I am not sure how many people took advantage of this deduction, probably not too many, but it was one way to encourage people to seek professional financial advice.

The sad truth is that the people who can afford financial advice are not those who needed it the most. So how about, make the financial advisory fees tax-deductible for low income and middle-class families. Or encourage financial advisors to provide free public service. I believe many of my colleagues will be happy to provide free advice in a meaningful and impactful way.

Reach out

If you’d like to discuss how to pay off your student loans, open a new 529 plan or make the most out of your existing 529 account, please feel free to reach out and learn more about my fee-only financial advisory services. I can meet you in one of our offices in San Francisco, Oakland, Walnut Creek, and Pleasant Hill areas or connect by phone. As a CFA® Charterholder with an MBA degree in Finance and 15+ years in the financial industry, I am ready to answer your questions.

Stoyan Panayotov, CFA 
Founder | Babylon Wealth Management

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Saving for college with a 529 plan

College savings with a 529 plan

What is a 529 plan?

The 529 plan is a tax-advantaged state-sponsored investment plan, which allows parents to save for their children college expenses.

In the past 20 years, college expenses have skyrocketed exponentially putting many families in a difficult situation.  Between 1998 and 2018, college tuition and fee have doubled in most private non-profit schools and more than tripled in most 4-year public colleges and universities.

College tuition and fees growth between 1998 and 2018.
Source: College Board

With this article, I would like to share how the 529 plan can help you send your kids or grandkids to college.

Student Debt is Growing

The student debt has reached $1.56 trillion with a growing number of parents taking on student loans to pay for their children’ college expenses. The total number of US borrowers with student loan debt is now 44.7 million.

Amid this grim statistic, less than 30% of families are aware of the 529 plan. The 529 plan could be a powerful vehicle to save for college expenses. Fortunately, 529 plans have grown in popularity in the past 10 years. There are more than 13 million 529 accounts with an average size of $24,057.

Let’s break down some of the benefits of the 529 plan.

College Savings Made Easy

Nowadays, you can easily open an account with any 529 state plan in just a few minutes and manage it online. You can set up automatic contributions from your bank account. Also, many employers allow direct payroll deductions and some even offer a match. Your contributions and dividends are reinvested automatically., so you don’t have to worry about it yourself. As a parent, you can open a 529 plan with as little as $25 and contribute as low as $15 per pay period. Most direct plans have no application, sales, or maintenance fees. 529 plan is affordable even for those on a modest budget.

529 plan offers flexible Investment Options

Most 529 plans provide a wide variety of professionally managed investment portfolios including age-based, indexed, and actively-managed options. The age-based option is an all-in-one portfolio series intended for those saving for college. The allocation automatically shifts from aggressive to conservative investments as your child approaches college age.

Alternatively, you can design your portfolio choosing between a mix of actively managed and index funds, matching your risk tolerance, timeline, and investment preferences. Some 529 plans offer guaranteed options, which limit your investment risk but also cap your upside.

Earnings Grow Tax-Free

529 plan works similarly to the Roth IRA. You make post-tax contributions. And your investment earnings will grow free from federal and state income tax when used for qualified expenses. Compared to a regular brokerage account, the 529 plan has a distinct tax advantage as you will never pay taxes on your dividends and capital gains.

Tax-exempt growth
529 plan versus taxable investment account
The chart hypothetically assumes a $6,300 annual contribution, a 5% average annual return and a 20% average tax rate on taxable income in a comparable brokerage account. The final year post-tax difference would be $14,539, without taking into consideration state tax deductions.on contributions and impact on financial aid application.

Your State May Offer a Tax Break

Over 30 states offer a full or partial tax deduction or credit on your 529 contributions. You can find the full list here. If you live in any of these states, your 529 contributions can lower significantly your state tax bill. However, these states usually require you to use the state-run 529 plan.

If you live in any of the remaining states that don’t offer any state tax deductions, such as California, you can open a 529 account in any state of your choice.

Use at Schools Anywhere

529 funds can be used at any accredited university, college or vocational school nationwide and more than 400 schools abroad. Basically, any institution eligible to participate in a federal student aid program qualifies. A 529 plan can be used to pay for tuition, certain room and board costs, computers and related technology expenses as well as fees, books, supplies, and other equipment.

The TCJA law of 2017 expanded the use of 529 funds and allowed parents to use up to $10,000 annually per student for tuition expenses at a public, private or religious elementary, middle, or high school. However, please check with your 529 plan as not all states passed that provision

Smaller Impact on Scholarship and Financial Aid

Many parents worry that 529 savings can adversely affect eligibility for scholarships and financial aid. Fortunately, 529 plan savings have no impact on merit scholarships. You can even withdraw funds from the 529 plan penalty-free up to the amount of the student scholarship.

For FAFSA, funds are typically treated as ownership of the parent, not the child, reducing the impact on financial aid application. A key component of the financial aid application is the Expected Family Contribution (EFC). Since 529 plans are considered parents’ assets, they are assessed at 5.64% of their value. For comparison, any accounts owned directly by the student such as custodial accounts (UTMAs, UGMAs), trusts and investment accounts are assessed at 20% of their value.

Lower Cost versus Borrowing Money

Starting the 529 plan early can save you money in the long run. The tax advantages of the 529 plan combined with the compounding growth over 18 years it will provide you with substantial long-term savings compared to taking a student loan.

529 plan provide Estate Tax Planning Benefits

Your 529 plan contributions may qualify for an annual gift tax exclusion of $15,000 per year for single filers and $30,000 a year for couples. The 529 plan is the only investment vehicle that allows you to contribute up to 5 years’ worth of gifts at once — for a maximum of $75,000 for a single filer and $150,000 for couples.

Other Family Members Can Contribute Too

Grandparents, as well as other family and friends, can make gifts to your 529 account. They can also set up their own 529 accounts and designate your child as a beneficiary. The grandparent-owned 529 account is not reportable on the student’s FAFSA, which is good for financial aid eligibility. However, any distributions to the student or the student’s school from a grandparent-owned 529 will be added to the student income on the following year’s FAFSA. Student income is assessed at 50%, which means if a grandparent pays $10,000 of college costs it would reduce the student’s eligibility for aid by $5,000.

Transfer funds to ABLE Account

Achieving a Better Life Experience (ABLE) account was first introduced in 2014. The ABLE account works similarly to a 529 plan with certain conditions. It allows parents of children with disabilities to save for qualified education, job training, healthcare, and living expenses.

Under the TCJA law, 529 funds can be rolled over into an ABLE account, without paying taxes or penalties.

Assign Extra Funds to Other Family Members

Finally, if your child or grandchild doesn’t need all the money or his or her education plans change, you can designate a new beneficiary penalty-free so long as they’re an eligible member of your family. Moreover, you can even use the extra funds for your personal education and learning new skills.