Personal finance

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LAS VEGAS — College is a major expense for many families, but a payment strategy can provide significant tax savings, according to a college funding expert.

“Distribution planning is not just for retirement,” said certified financial planner Ross Riskin, chief learning officer for the Investments & Wealth Institute. Families also need a plan when tapping assets to pay for college, he said.

Education funding can be complicated, especially when you’re juggling eligibility for college tax credits, Riskin said at the American Institute of Certified Public Accountants’ annual conference in Las Vegas on Monday.

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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 lifetime learning credit expands to graduate and professional degrees, worth up to $2,000 per eligible student per year.

However, you can’t “double dip” tax breaks by claiming one of these credits and withdrawing money from a 529 college savings plan for the same expense. So to claim the full value of the credit, you’ll need to plan ahead to cover a portion of tuition using income, loans or other eligible sources.

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“What you pay does not equal what it costs you,” said Riskin, who is also a certified public 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 student loans.

If your effective tax rate is 35% and you pay for college with $30,000 of after-tax dollars, it actually costs you $46,000, he said. You may also tap a 529 plan, which may have grown from $18,000 of contributions, for example, and can provide tax-free withdrawals for eligible expenses.

What you pay does not equal what it costs you.
Ross Riskin
Chief learning officer for the Investments & Wealth Institute

While taking out student loans may seem counterintuitive, the strategy may offer tax-free loan forgiveness for certain future nonprofit and government employees. What’s more, student loans may provide other benefits like the ability to claim the American opportunity tax credit or establishing credit for the student, Riskin said.

“Advisors have done themselves a disservice of trying to simplify it,” he said, noting that many families default to 529 withdrawals without analyzing other options.

How to weigh 529 plan withdrawals

When it comes to 529 plans, there’s also the choice of whether to spend the money now or preserve it for family members, such as other children or even grandchildren, Riskin said. (Starting in 2024, a change in the law will allow families to roll qualifying unused funds into a Roth IRA, with limitations.)

While the Secure Act expanded qualified education expenses for federal taxes, some states don’t recognize these costs for state tax purposes. For example, K-12 education is not a qualified education expense in New York.

If your withdrawal exceeds your qualified expenses or you take money after the year expenses were incurred, you may owe extra taxes and a penalty. There’s also a risk the state may recapture any state tax deduction previously received for contributions. “The recapture piece is important,” Riskin said.

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