If you are nearing retirement, then you should have some kind of retirement savings plan in place. If retirement is still relatively far off for you, then now is the time to start preparing.
Contributing to a 401(k) or similar work-sponsored retirement plan is one of the best and easiest ways to invest in your future. Plan contributions are automatically deducted from your wages and invested in a tax-advantaged account before you receive your paycheck, which removes any temptation to spend it.
Nearly 90 percent of employees who are eligible to participate in a 401(k) plan choose to do so, and they contribute an average of 6.7 percent of their earnings. Have you ever wondered where those contribution dollars go?
According to Plan Sponsor Council of America, the percentage of employees who make contributions, by type are — 78 percent to traditional pre-tax contributions, 26 percent to Roth after-tax contributions, and 30 percent to catch-up contributions (age 50+).
“When talking about preparations for retirement one should also consider another smart investment which can help keep the taxman off your doorstep,” advises Richard Lerner, Senior Vice President, Investments at David Lerner Associates. “529 plans are an excellent way to save for college and the tax benefits and other advantages they offer when funds are used to pay a beneficiary's qualified college expenses are simply unmatched.”
Recent Boost for 529 Plans
Up until now, the FAFSA (Free Application for Federal Student Aid) treated grandparent-owned 529 plans more harshly than parent-owned 529 plans. This will change thanks to the FAFSA Simplification Act that was enacted in December 2020. The new law streamlines the FAFSA and makes changes to the formula that's used to calculate financial aid eligibility.
The old rules state that parent-owned 529 plans are listed on the FAFSA as a parent asset. Parent assets are counted at a rate of 5.64 percent, meaning 5.64 percent of the value of the 529 account is deemed available to pay for college. Later, when distributions are made to pay college expenses, the funds aren't counted at all; the FAFSA ignores distributions from a parent 529 plan.
Grandparent-owned 529 plans on the other hand, did not need to be listed as an asset on the FAFSA. While this may sound like a benefit, the catch is that any withdrawals from a grandparent-owned 529 plan were counted as untaxed student income in the following year and assessed at 50 percent. This could have a negative impact on federal financial aid eligibility.
The new rules, which take effect in October 2022, state that grandparent-owned 529 plans still do not need to be listed as an asset, and distributions will no longer be counted as untaxed student income. Additionally, the new FAFSA will no longer include a question asking about cash gifts from grandparents. This means that grandparents will be able to help with their grandchild's college expenses (either with a 529 plan or with other funds) with no negative implications for federal financial aid.
One thing to consider though is that grandparent-owned 529 plans and cash gifts will likely continue to be counted by the CSS Profile, an additional aid form typically used by private colleges when distributing their own institutional financial aid. It's most certainly not a one-size-fits-all solution — individual colleges can personalize the CSS Profile with their own questions, so the way they treat grandparent 529 plans can differ.
As a retiree, and as a grandparent, these changes are certainly of interest. Tuition costs have largely been unchanged since Covid, so it’s worth taking a look at the various options for paying for college if that is on your to-do list. If you have ever contributed to college costs for your children or grandchildren, you are probably already familiar with 529 plans.
529 plans have an added benefit, even if you don’t have grandkids, because they can be used for your own continued education as an adult — you get the same tax breaks and benefits of any 529 plan owner. You can fund the account with new money or with unused money from a child’s account. And any leftover money in your 529 plan that you don’t use can be transferred to the 529 of a child or grandchild.
Depending on your state of residence — it would be smart to do some homework and due diligence since some states have better tax perks than others. You can find details about different state plans online. There is no federal tax deduction for 529s, but residents can usually get a state tax deduction on contributions made to their own state’s plan. Fortunately, you can choose a plan in another state, which could be a smart move if your state of residence doesn’t offer deductions and another state’s plan offers better investing options or lower fees.
Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. This material does not constitute an offer or recommendation to buy or sell securities and should not be considered in connection with the purchase or sale of securities.
To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable-- we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
David Lerner Associates does not provide tax or legal advice. The information presented here is not specific to any individual's personal circumstances.
Member FINRA & SIPC.