Save for your Future Expenses while Saving on Taxes
By Krutika Chheda Winter has set in and along with the heavy coats and jackets, the burden of pulling all the paperwork for the tax return will soon be upon all of us. And like every tax season there will be a hope for a bigger tax refund. With the cost of education and the risk of retiring with fewer savings rising each year, tax payers often wonder how they can keep more of their hard earned money for themselves and their family. 529 College Savings Plan Tax Benefits of a 529 College Savings Plan State Income Tax Benefits In case of South Carolina, the absolute tax benefits can be even greater. The state offers unlimited state tax deductions for 529 contributions by South Carolina State residents into a South Carolina qualified plan. So South Carolina Taxpayers can deduct any amount they contribute to a South Carolina 529 Plan, so long as there is income to deduct. Gift and Estate Tax Benefits Gift and Estate tax is a complex subject and requires extensive tax planning. For grandparents that invest the time in the planning process, this is a great way to leave behind a legacy of higher education for the next generation while saving on the heavy burden of taxes. Here is a link for more details on the estate tax planning: http://kmtaxservices.com/estateplan.php
Higher education in the US is not only very competitive, but also very expensive. Based several reports, the average cost for undergraduate college tuition, fee and boarding has been rising each year at an astonishing 8 percent. It was on average about $15,300 per year for 4-year public in-state college and $35,700 per year for 4-year private college a few years ago. Not all of the money needs to come from the parents or students. Many full time students manage to get financial aid in the form of grants, scholarships. Some reports indicate that students on average secure financial aid up to $14,400 per year in a private college and $5,400 per year in a public college. In addition to that there is potential for tax breaks and tax savings for parents.
Saving for children’s education requires a long term plan. And like saving for retirement, the earlier one begins to plan the better! Use this calculator on K&M Accounting and Tax Services website to help develop and fine tune your education savings plan: http://kmtaxservices.com/calc-section.php
One of the most popular vehicles for college savings is the 529 Plan. Most states have a 529 program allowing parents to save for future higher education with tax benefits.
Parents can make regular contributions to the 529 account. Each state has different rules on the nature of the account and beneficiaries, however in general the account owner (contributor to the fund) controls the funds and the beneficiary (student) gets to use the funds for qualified higher education. States also vary in the limits to the extent of the annual contributions and tax deductions allowed on the state income tax return. Here’s a site that provides a list of different state rules: http://www.collegesavings.org
There are multiple ways one can derive tax benefits from the 529 college savings plan. Although contributions made by the account owner are not deductible for federal income tax purposes, earnings on contributions grow tax-free in the program. For example if your initial investment of $5000 in the 529 plan grows over time to $20,000, you will not have to pay any federal income tax on the $15,000 in gains when you withdraw the money to pay for qualified higher education. This is a great benefit as compared to the capital gains tax or marginal individual tax rate you would have to pay on the $15,000 in gains.
Distributions from the 529 college fund are tax-free to the extent used for qualified higher education expenses such as college tuition fees, books, supplies, equipment, and special needs services. Distribution for a purpose other than qualified education is taxed to the one receiving the distribution. In addition, a 10% penalty must be imposed on the taxable portion of the distribution.
Several states including North Carolina offer tax deductions for 529 contributions. North Carolina residents who contribute to a North Carolina 529 Plan receive a state income tax deduction of up to $2,500 per contributor if filing single and $5,000 if married filing jointly.
Considering that the top income tax rate in North Carolina is 7.75 percent, a full $5000 contribution can save a taxpayer up to $387.5 at tax time. Given the current low deposit rates offered by banks, a 7.75 percent upfront return in the very first year is pretty good! Add to it the federal tax benefit on the future gains in the account and you may have as much as 15 percent or more in tax savings depending on your individual tax situation. Over a period of time this can add up to a substantially large sum of money. A little tax planning can take your savings much further.
Friends and family members can also help contribute to your child’s education by way of gifts. They can contribute up to $13,000 annually to be excluded from gift tax. 529 programs can also be an attractive estate planning move for wealthy grandparents planning to pass on their wealth to grandchildren. There are no income limits, and the account owner giving up to $65,000 avoids gift tax and estate tax by living 5 years after the gift.
Keep in mind this column and the articles published here are only meant to provide you with high level information about tax and business matters and in no way should you consider this as tax advice. Consult your tax and legal advisors regarding your individual tax and business situation. This Article provides only an overview to the complex Tax Laws. It is not exhaustive nor a substitute for Independent Tax Advice provided by a Tax Accountant or a Tax Attorney familiar with your case.
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