Section 529 Plans Can Provide Tax-Smart Learning for Kids and Adults
Contributing to a Section 529 Plan before year end on behalf of children or grandchildren can be a wise idea. But have you ever thought about
one of these tax-favored accounts for yourself — to pay for post-secondary courses you might want to take in the future?
Adults can open up Section 529 plans (also called Qualified Tuition Programs) and make themselves the beneficiaries. The plans allow you to put money in a state plan for tuition, fees, books, supplies, and equipment that are required to attend an eligible educational institution.
What’s an eligible school? “It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions,” according to the IRS.
That means you can generally use withdrawals to study for a second career, go to graduate school, or do coursework in retirement.
Section 529 advantages include:
Your account grows tax-free and withdrawals are not federally taxed when used for eligible education expenses.
Many states allow income-tax deductions (up to different annual maximums) for contributions to the state’s plan — and some don’t tax withdrawals.
There are no income limitations and you can put a substantial amount into a plan at one time.
What if you don’t use the money? You can change the beneficiary to a family member or leave the account alone and let it become part of your estate. Another option is to withdraw the money. However, the earnings will be subject to federal (and any state) taxes, as well as a 10 percent penalty. (The penalty doesn’t apply to the principal.)
Make a Last-Minute Swap of Munis
You might want to arrange a municipal bond “swap” to reduce your 2006 tax liability.
In reality, a bond swap is the simultaneous sale of one bond and purchase of another issue. Typically, you may sell a bond that’s showing a loss and acquire a bond with similar investment characteristics. When the swap is complete, you’re essentially in the same investment position as you were before the exchange took place.
Tax difference: Now you have a current loss that you can deduct on your 2006 tax return. And if the bond you acquire in the swap has higher interest, so much the better.
More muni bonds are usually available for exchange at year-end than corporate bonds. But the marketplace can be thin, so move quickly.
Example: Suppose you own an Apple City muni purchased years ago for $10,000. The bond’s current value is $8,000. It will mature in 18 years and has a 4.5 percent interest rate. Currently, you’re showing a net $2,000 gain in capital gain transactions. So you swap your Apple City bond for an Orange City muni.
The Orange City bond also has a face value of $10,000 and a current value of $8,000. However, as opposed to the Apple City bond, it matures in 20 years and has a coupon rate of 5 percent.
Benefits: The $2,000 loss from the sale part of the swap eliminates your capital gains tax for the year. Next, you get a small increase in annual income. Instead of earning $450 of tax?free interest each year, you are entitled to receive $500 tax?free.
Caution: Under the “wash sale” rule, you cannot realize a tax loss from a security sale if you reacquire a substantially identical security within 30 days. To avoid this, consider swapping bonds of different issuers. Or if the bonds come from the same issuer, make sure there’s a significant difference in the maturity dates and interest rates