Don't Mess With Taxes

Photo by Juan Ramos on Unsplash

May is graduation month. It's also graduate gift giving time.

Money is always tight for the new diploma recipients (and their families), regardless of whether they've completed high school or college. That's why financial gifts are always welcome.

One of those graduate gifts for students looking to continue their school days is a contribution to their 529 plans.

And one source of those contributions could be, for older savers, their required minimum distributions.

Quick 529 overview: These savings plans, named from the Internal Revenue Code that created them, originally only covered higher education expenses. However, over the years Congress has expanded the funds' uses beyond eligible college costs. They now can help pay expenses incurred for K-12 classes, as well as cover apprenticeships and student loan repayment.

Even better, 529 plan earnings grow tax-deferred at federal and most state levels. The money can be withdrawn tax-free to pay qualified educational expenses. Some states also offer a state tax deduction for 529 plan contributions.

All 50 states and the District of Columbia offer some type of 529 plan. However, you're not limited to opening one in the state where you live. You can explore and compare plans nationwide with SavingForCollege.com's interactive 529 map.

Another one of the many benefits of these tax-advantaged educational savings accounts is that they accept third-party contributions, regardless of who owns the account. Of course, if you contribute to a 529 plan, you'll need to talk with the student's family, since it could affect a student's financial aid eligibility.

Quick RMD overview: Now to savings for folks who are well past their graduation days. If they — you — stashed your retirement money in tax-deferred accounts, you'll eventually have to withdraw it on an annual schedule.

The Internal Revenue Service sets the payment amounts, known as required minimum distributions or RMDs, based on your age and amount of your affected nest egg.

Under recently-enacted retirement law changes, popularly known as the Secure Act 2.0, as of Jan. 1, 2023, RMDs begin when you turn age 73. If you hit the prior age 72 RMD trigger age in 2022 or earlier, you must continue taking RMDs.

Although the penalty for not withdrawing the required amount has been eased, it's still substantial. And let's be honest. None of us wants to pay Uncle Sam any more money than we absolutely must.

529 + RMD = good news for all: If you must take an RMD, but don't need the money to cover your living expenses, you have options.

One is to give up to $100,000 of your RMD to a qualified charity via a direct transfer known as a qualified charitable distribution (QCD). This will satisfy your RMD, and the donated money isn't counted as your taxable income. Find more on this option in my post The tax-saving ABCs of RMDs and QCDs.

Or you can use all or part of your RMD as a contribution to a younger person's 529 plan.

Yes, the RMD will be taxable, but at least by taking it you'll avoid the non-withdrawal tax penalty. And if you adhere to the charity begins at home school, then giving the money to a relative or family friend instead of a nonprofit could work.

Two 529 gift options: You can put your retirement withdrawal into the student's 529, which is owned either by the youngster or the parents with the student as beneficiary.

Or you can put your RMD into an account owned by you with the student as the beneficiary. This choice, often called a Grandparent 529, is popular primarily because it offers a way to give an amount much larger than the usual gift tax limit.

For the 2023 tax year, the maximum amount you can give a person in a year without having to pay gift taxes is $17,000. But if you put the money directly into a 529 plan, you can contribute up to $85,000 this year ($170,000 if you are a married couple filing jointly) and not face gift tax as long as you treat the contribution as if it were spread over a 5-year period.

Again, regardless of which 529 contribution you choose, talk with the student and family, since the gift could affect need-based financial aid they also are considering. And, of course, speak with your own tax and financial adviser and/or estate planner.

But if it works for all involved, the convergence of an RMD and 529 could add up to a nice way to celebrate graduation.

You also might find these items of interest:

• Tax-smart ways grandparents can help pay for college
• Tax credit lesson: American Opportunity vs. Lifetime Learning
• Make paying for college a family affair, with contributions from parents, kids & Uncle Sam

Advertisements