Tax-Intelligent Tips for Back-to-School Season

Between shopping lists and adjusting to new routines, back-to-school season can be overwhelming – but it’s a wise time for Financial Professionals to check in with their clients about tax-intelligent ways to plan for educational expenses. Whether your clients are parents of young children or going back to school themselves, we’ve turned to the Avantax Community – including our Home Office and Financial Professionals – to provide some helpful tips you may want to explore with your clients.

529 Beneficiaries & IRA Withdrawals

Joseph Reid, CFP®, ChFC®
Financial Advisor, Link Wealth Strategies

It's never too early to start saving for future education expenses – and a 529 plan can help with that.

Many clients are surprised when I explain they can start a 529 as the owner and beneficiary before they even have children! This is because they’re able to change the beneficiary (the person who is designated to use the funds from the plan) to a family member at a future date. In other words, the client can establish the 529, contribute to the account, and then change the beneficiary to their child in the future. 

I always make my clients aware that a 529 plan account can only have one beneficiary at a time, so they may have to split accounts later if they have multiple children. Additionally, when the client wants to change their 529 beneficiary to someone who is one or more generations younger than the previous beneficiary, it’s considered a gift for tax purposes. This can trigger the need to file a gift tax return if they’re over the annual exclusion ($18,000 in 2024). Because 529 plan accounts are state sponsored, financial professionals should ensure they’re aware of any variances depending on which state their client lives in.

Another way to fund educational expenses involves the client’s IRA. Although it’s not always advisable to take an early distribution from retirement savings, clients should be aware that the 10% early withdrawal penalty that usually applies before age 59.5 on IRA withdrawals can be waived when used on qualifying higher education expenses.  

Educational Tax Credits

Chris Kadowaki, ChFC®, CFP®, EA
Financial Planner, Avantax Planning Partners

When preparing a financial plan for clients who are in the midst of paying for higher education costs, it’s important to review the education credits they may qualify for to help ensure they’re taking the most tax-intelligent path. Certain taxpayers can take advantage of the American Opportunity Tax Credit (AOTC) and the lifetime learning credit (LLC) by paying for qualified education expenses. 

It’s important to note these credits are subject to income limitations: Modified gross income cannot be higher than $180K if filing married or higher than $90K if filing single or head of household.

• The AOTC is available to those paying for higher education for themselves or their dependents. Eligible expenses must be applied to a student completing their first four years of higher education, and the student must be enrolled at least half time for the education expenses to be qualified.
• The LLC is also available to those paying for higher education for themselves or their dependents. This credit differs from the AOTC in that eligible expenses can be applied to undergraduate, graduate and professional degree classes and a student has to be enrolled in at least one course.
  • Recent changes to the LLC have expanded eligibility to take advantage of this tax credit. Beginning in 2021, the LLC’s income threshold has been raised to match the AOTC’s income limitations, allowing for more individuals to qualify.

529 Plan Considerations

Davin Carey
Financial Planning Consultant, Avantax

My 7-year-old son started 2nd grade this year. I’m already thinking about how, in 11 more years, he’ll be wrapping up his senior year of high school and then off to his next adventure – hopefully college. We can’t wait to see what path he chooses.

One thing we don’t anticipate having to worry about is paying for his higher education. That’s because we’ve been funding 529 college plans since he and our daughter were born. These plans grow 100% tax free and the withdrawals they take for their qualified education expenses in the future won’t be subject to federal income tax. We’ve been fortunate that their grandparents have chipped in, too, helping reduce that future burden.

And thanks to SECURE 2.0 Act, if our kids don’t end up needing the full amount we’ve saved in their 529 accounts, they can roll up to $35,000 of unused 529 assets into Roth IRAs to help them on their future retirement plans.

Consider this hypothetical scenario: Your client’s child doesn’t end up attending higher education and rolls that $35,000 into a Roth IRA and don’t touch it until they’re age 60. At the 10.26% S&P 500 average rate of return (from its 1957 inception through end of 2023), your client’s child would have nearly $1.4 million in that IRA account, completely tax free.

It’s important that Financial Professionals remind their clients who are parents/grandparents to put as much time on their side as possible. Ensure they don’t wait to start saving – next year, their kids/grandkids will be a year older, college will be a year closer and they’ll be late to the game on realizing the tax-free growth potential a 529 provides.

With a little tax intelligence, you can really make a positive impact on your child’s financial future!

Wash Loans

Jason Allen, CFP®, CLU®, CLTC, CAS®
Life Insurance Sales Specialist, Avantax

Life insurance policy owners can help pay for qualified student expenses by borrowing against the cash value of their life insurance. It’s a tax-efficient strategy that doesn’t affect a student’s qualification for financial aid.

This solution may make sense for clients who have ample cash value in their policy. The client can borrow from their policy at a rate almost equal to the loan interest the carrier charges them (referred to as a “wash loan”).

As with any financial strategy, there are important considerations to keep in mind. Any cash value reduction will reduce your client’s policy death benefit dollar-for-dollar. Additionally, not every client will qualify. But for those who need a tax-intelligent, outside-the-box way to fund college expenses, this could be a game changer. 

Scholarships, Budgeting and More!

Jason Weier
Owner & Financial Advisor, Weier Wealth Management

A large part of being a financial professional is ensuring your clients are prepared for major life events. Paying for college is no exception, and it can be especially intimidating if clients aren’t sure what the final bill will amount to. Here are five talking points financial professionals should keep in mind as they guide their clients who are preparing for higher education expenses.

1. Take Advantage of Scholarships
Nearly $100 million in scholarships go unclaimed each year due to a lack of applicants. Encourage your clients to apply for any scholarships they qualify for – it could make a big difference in the long run.

2. Review Impacts on Budget
Help your clients understand the bigger picture of this financial commitment by running projections on anticipated education costs and how those fit into their current budget.

3. Start Saving Early
Encourage your clients to take advantage of a 529 plan or ESA. The earlier they start contributing, the more time their investment has to grow, thus potentially lowering how much they need to contribute.

4. Maximize SAT or ACT Scores
Not all colleges and universities require SAT or ACT tests for admission, but strong test scores can still go a long way in earning scholarships and financial aid. If their initial score was less than stellar, remind clients they can retake the tests to try for a better outcome.

5. Understand In-State vs. Out-of-State Tuition
Is your client planning to attend university in a different state than where they currently reside? Ensure they are aware of the dramatic difference between in-state and out-of-state tuition and help them plan their costs accordingly.

Plan for What You Can!

Jennifer Milligan, CFP®
Financial Advisor, Strojny Financial Services

My husband and I recently helped our daughter begin her college journey, which entailed a lot of planning and preparation! It reminded me why it’s so important to help my clients financially anticipate these major life events. Based on my experience over the past several weeks, here are a few topics I’d recommend every financial professional review with their clients:

1. 529s. Since 529 plans are state sponsored, it’s important to know your state’s 529 plan rules so you can appropriately advise your clients. Additionally, ensure your client isn’t taking the full annual need out of a 529 plan without evaluating potential tax credits and other funding options. It may make sense for your client to stretch out the use of the 529 instead so they get full available tax credits.

2. Budgeting. As those of us with kids in college know, expenses can quickly add up! Although some unknowns are inevitable, planning for set costs was extremely helpful as compared to guessing what the final price tag will be. That’s why we opted into our daughter’s college “book bundle” package. This program provides her books and class-specific materials at a fixed cost every semester through the campus bookstore. I encourage my clients in similar situations to look out for and take advantage of this type of program. 

3. Save on Supplies. Speaking of expenses, remind your clients to take advantage of state sales tax holidays and online retailers’ special sales days for school supply deals and tax savings. I got everything I needed for my daughter’s dorm room during an online retailer’s “sales day” for approximately $500!