529 Contribution then Immediate Withdrawal

[45th Birthday]

I have a 529 plan which won't cover all my kids' college expenses. I haven't contributed anything this year. My state has a deduction for a maximum $20,000 per year contribution which at the 4.5% tax rate would save $900.

I'm thinking of opening a 529 online, funding it with $20,000 with investment in a money-market like account, then immediately withdrawing it. The withdrawal would be for qualified expenses. Does anyone see a problem with this? It sounds to good to be true.

 

[FUEGO]

No problem from what I know of my state's rules. But you might be better off with tax deductions/credits for paying for college (if you aren't already using them).

 

[calmloki]

Worked for me in Oregon, though for much less than $20,000 - I was just contributing what could be written off for the year against our state tax AGI and contributing toward a nephew's tuition.

 

[45th Birthday]

No chance for college credits or deductions.

 

[jIMOh]

No problem from what I know of my state's rules. But you might be better off with tax deductions/credits for paying for college (if you aren't already using them).

+1

consult your tax professional.

Is it better to get a $900 tax DEDUCTION or possibly a $3000 tax CREDIT?

 

[jIMOh]

No chance for college credits or deductions.

Why?

Are you sure? Usually the credits change limits every Dec 31 or Feb 1, meaning it is possible you make a decision now, and then in Feb you might find out about a credit you could have used too.

Ask a tax professional.

 

[45th Birthday]

Thanks for the advice. I'm over the phase-out limits for American Opportunity, Lifetime Learning Credits, as well as the tuition and fees deduction. I was really asking more from the standpoint of the state tax benefit.

 

[kaneohe]

.......and no such income limits for state?

 

[SecondCor521]

I did this when getting my master's -- I'd contribute, then withdraw and pay my tuition, then take the deduction. I read all the rules very carefully and chatted with the 529 folks, my state tax folks, and my university folks and it appeared to be OK.

2Cor521

 

[Nords]

I'm thinking of opening a 529 online, funding it with $20,000 with investment in a money-market like account, then immediately withdrawing it. The withdrawal would be for qualified expenses. Does anyone see a problem with this? It sounds to good to be true.

It's what we do.

Our education savings bonds can't be used tax-free for educational expenses other than tuition, but when we cash them in and roll them through the 529 then they can be used to pay room/board and still be tax-free.

Is America a great country or what?!?

 

[Brett_Cameron]

I am assuming this practice is beneficial because of the savings in state income taxes on the contributions?

The contributions are not excluded from federal taxable income.

The contributions may be excluded from state taxable income. (maybe always?)

Distributed earnings are not taxable by the state or federal.

 

[SecondCor521]

I am assuming this practice is beneficial because of the savings in state income taxes on the contributions?

Ah-yup. In my case I could contribute $4000 per year and get a state deduction for that amount. Idaho's top marginal rate is about 8%, so I was saving $320 per year just with some paperwork. Other states with better 529 deductions and/or higher marginal rates make the idea even better.

2Cor521

 

[45th Birthday]

In Illinois, there is no income limit, but there is a $20,000 limit (joint return) for the deduction. In the early days of 529 plans, there was no limit. They only give this for the state-affiliated plans. Kind of takes the sting out of the recent 67% increase in the state income tax.

In general, Illinois, like other states, has some good tax policies and some bad ones. For example, they pretty much tax you (with the 529 deduction and a few other exceptions) on your federal AGI-no significant deductions. So stuff like mortgage interest, real estate taxes, charitable contributions don't matter. However, there is no tax on retirement income, so for example I can do a Roth conversion and it doesn't hit my Illinois return.

Thanks for giving me peace of mind on this strategy. It is good to hear others are doing it with no problems.

 

[Dimsumkid]

In general, Illinois, like other states, has some good tax policies and some bad ones. For example, they pretty much tax you (with the 529 deduction and a few other exceptions) on your federal AGI-no significant deductions. So stuff like mortgage interest, real estate taxes, charitable contributions don't matter.

IL does allow you to deduct your RE taxes.

 

[45th Birthday]

Yep, you are correct. I flubbed that one. I looked back and in 2010 I got a nonrefundable credit of 5% of my property tax (Illinois tax only).