Tax Strategies

Many of your have heard of the popular 529 savings plans that custodians can set up to fund their child or grandchild’s college education. Earlier this year, you likely also heard about the SECURE 2.0 Act which brought down some of the biggest changes to retirement and savings plans in recent years. But what does college planning have to do with retirement planning and how could the new legislation make 529s even more attractive than they were before?

Understanding the SECURE Act 2.0 and 529s

For those unfamiliar with the jargon, let’s get the basics out of the way. The SECURE Act 2.0, or the “Setting Every Community Up for Retirement Enhancement” Act, is legislation that primarily aims to help individuals increase and protect their retirement savings. But hidden within this big retirement package are some intriguing updates to 529 college savings plans.

A 529 plan, in simple words, is a tax-advantaged savings plan designed to encourage saving for future education costs. Typically, these plans allow families to invest after-tax dollars that grow tax-free. And, when the time comes, withdrawals for qualified education expenses are also tax-free.

Breaking Down the Benefits of SECURE 2.0 to 529s

But what does the SECURE Act 2.0 have to do with these 529s, you ask? Well, it broadens the definition of “qualified education expenses” and enhances the flexibility of these plans.

Thanks to SECURE 2.0, 529s now cover costs related to apprenticeships, and — here’s the big kicker — student loan repayments. Yes, you heard it right! You can now use the 529 plan to repay up to $10,000 in student loans. This new feature alone could make 529s far more appealing to many families.

Additionally, under SECURE 2.0, if your child gets a scholarship, you can now withdraw the amount of the scholarship without the usual 10% penalty. That means more flexibility to adapt to life’s surprises.

Balancing the Pros and Cons of 529 Plans

Now, does this make 529s more attractive? It’s not a simple “yes” or “no.” While these changes certainly sweeten the deal, they don’t fundamentally alter the nature of 529s.

529s remain an investment tool best suited for those quite certain about their children’s path to higher education. If your family’s situation matches this description, the expanded benefits under the SECURE 2.0 Act could indeed make the 529 plan more attractive.

However, if there’s considerable uncertainty about your child’s educational future, or if your family might not be able to take advantage of the new benefits (like the ability to pay off student loans), the enhanced 529 might not seem much more attractive than before.

The Risk? The Tax Costs of Overfunding a 529

The reason that we say 529s are an investment tool best suited for those “quite certain about their children’s path to higher education” is because a new J.P. Morgan study found that a 529 account is still the most tax-efficient way to save for a student’s education—but only if that account is actually used and depleted by the time the student completes their education.

That’s because removing the funds from the 529 for non-qualified expenses triggers a tax event. If the beneficiary does not go to school or does not finish school, the custodian has two choices:

• Take back the money in the 529 account or give it to the student. However, in both cases, taxes and a 10% penalty must be paid on the earnings at the recipient’s ordinary income tax rate. If the student is in a lower tax bracket, it makes most sense for the student to receive the funds and pay taxes at the lower ordinary income rate.
• Pass the account on to a lower generation (e.g., grandchildren). But there would be a tax liability for this option as well. The initial beneficiary might have to use some of the $12.92 million gift tax exclusion when a new beneficiary is named.

In other words, if you aren’t sure your child will attend college or may not complete a full four years, you’ll want to look at other options to avoid these tax implications. Other options include a pay-as-you-go approach, funding UTMA accounts, or setting up grantor trusts.

Choosing the Most Impactful Path

The SECURE 2.0 Act has brought some considerable enhancements to the 529 college savings plans, making them potentially more attractive to many families. However, whether these changes tip the scales in favor of a 529 plan for you and your family will largely depend on your specific situation and needs. A 529 account is the most tax-efficient education savings alternative, but only if the account is exhausted when the student’s education is completed.

As always, remember that financial planning is a personal journey. It’s essential to consult with a professional advisor who understands your financial goals and circumstances. If you’d like to discuss these changes and see how they impact your current financial strategy, don’t hesitate to get in touch!

At Platt Wealth Management, our team of financial advisors are ready to understand your goals and dreams in order to present the right solutions to your needs and opportunities that will simplify your financial life. We would love to learn more about you with a complimentary Discovery Call. Contact us today to discuss your opportunities.

Platt Wealth Management offers financial plans to answer your important financial questions. Where are you? Where do you want to be? How can you get there? Our four-step financial planning process is designed to be a road map to get you where you want to go while providing flexibility to adapt to changes along the route. We offer stand alone plans or full wealth management plans that include our investment management services. Give us a call today to set up a complimentary review. 619-255-9554.

Where there is income, there will be tax. So, it’s no surprise that building a successful retirement income plan will have a lot to do with how much tax you will pay on your account withdrawals.

In all honesty, planning for the “money-out” phase of retirement is often more complicated than the “money in” phase. That’s why it’s often likened to climbing Mt. Everest—because 80% of injuries occur not on the way up, but on the way down.

So how do you limit your tax liability to improve your odds of retirement success? Here are a few considerations to get you started.

First, understand how your retirement income will be taxed.

It is much easier to shield your money from taxes during your retirement plan’s accumulation phase than in the distribution phase. That’s because, as you start receiving income in retirement, the IRS can come at you in ways you may not have considered.  An income source on the left will affect the tax treatment on the right and could affect your Medicare and Social Security in the background. Like we said, there are a ton of moving parts.

What this means is that what you see on the surface, as far as your retirement account balances and your projected cash flow from these accounts, may be different from what you actually get. So many retirees are blindsided with lower-than-expected cash flows because they weren’t prepared for how their income would be taxed.

• Ordinary income taxes on withdrawals.

The money accumulated in your 401(k) or IRA is worth less than the amount stated on your account statement. That’s because, after all the years of tax-deferred accumulation in those accounts, the IRS is waiting in the wings to get its share. That happens as soon as you start taking distributions, which are taxed as ordinary income. 

So, if you have accumulated $500,000 in your 401(k) or IRA, here is what it would be worth after taxes:

$325,000 if you’re in the 35% tax bracket

$315,000 if you’re in the 37% tax bracket

Understanding where you stand on an after-tax basis is crucial in planning your distributions, so they have the most negligible impact on your tax bracket. It also puts you in a position to consider strategies that can help mitigate the impact of taxes. 

• Requirement minimum distributions: If you think you can avoid taxes by not taking distributions, the IRS forces you to take withdrawals starting at age 73 through the required minimum distribution (RMD) rules, whether you need the income or not. This can have the effect of pushing you into a higher tax bracket, increasing your tax liability. However, with that understanding, you can explore strategies to mitigate its impact. 

• Social Security “tax torpedo”: Not only are withdrawals from tax-deferred accounts fully taxable, but they can also trigger the Social Security “tax torpedo,” which exposes as much as 85% of your Social Security benefits to ordinary income taxes. 

Then, choose strategies for controlling taxes in retirement.

Knowing what they know now in terms of retirement income taxation, many retirees would probably have chosen a different strategy that included allocating more of their retirement contributions among post-tax accounts that generate tax-favored capital gains or a Roth IRA for its tax-free withdrawals (which are is not considered provisional income included in the Social Security tax calculation). 

However, retirees knocking on retirement’s door still have an opportunity to develop an income strategy that can effectively minimize their taxes and stretch their assets further into the future. 

Tax-Efficient Withdrawal Strategies: An essential strategy for reducing taxes on retirement account withdrawals is implementing a tax-efficient withdrawal strategy. This involves withdrawing funds from taxable accounts before tax-deferred accounts, which can help reduce tax liabilities with a more favorable capital gains tax. It’s essential to work with a financial advisor to determine the best approach for your situation.

Consider a Roth IRA conversion: While contributions to a Roth IRA are not tax-deductible as with traditional IRAs, withdrawals are tax-free. A Roth’s tax-free income in retirement can lower your overall taxes in several ways, not only increasing your cash flow but also extending your retirement capital further into the future. 

• The tax-free income will not push you into a higher tax bracket, as would taxable withdrawals from a tax-deferred qualified retirement plan.
• The tax-free income will not count towards the stealth Social Security tax torpedo on excess earnings.
• There is no required minimum distribution rule for a Roth IRA, enabling you to keep growing your retirement capital tax-free. 

The tax code allows individuals who otherwise don’t qualify for a Roth IRA to fund a traditional IRA or 401(k) plan and then convert it to a Roth. There is no income limit or limit on how much or how many times you convert. 

When you do convert, it triggers a tax on the conversion amount because it is treated as a taxable distribution. For example, if you transfer $10,000 from a tax-deferred qualified retirement account to a Roth, that amount is added to your adjusted gross income (AGI) and taxed at your federal tax rate. 

 If you have $100,000 in a traditional IRA, it can be converted all at once. However, considering the tax implications, it may be better to convert portions of it over several years. 

Qualified Charitable Deduction to Offset RMDs: A Qualified Charitable Deduction is a direct, tax-free transfer of funds from your IRA to a qualified charitable organization. To be eligible, you must be at least 73 and ready to take your first RMD. It’s a direct transfer, so the check must be payable to the charitable organization by December 31 to qualify. If married, you and your spouse can each transfer up to $100,000 tax-free from your IRA each year, even if it exceeds your RMD.

The QCD is unavailable for 401(k) plans, SEPs, or SIMPLE IRAs. However, if you roll any of those plans into an IRA, it becomes QCD eligible. 

These strategies have tax implications, and everyone’s tax situation is different. You should always consult a qualified professional tax advisor to discuss your specific tax situation and how these tax reduction strategies apply to your situation. 

Find the Plan That’s Right for You

At Platt Wealth Management, we like to encourage our clients to dream, plan, and do. Don’t let an underdeveloped tax strategy get in the way of “doing” all you’ve dreamed and planned for.

If you’re in need of a financial guide to help you make your way through the “money in” and/or “money out” stages, we would love to see if we’re a good fit. Simply schedule your complimentary phone consultation to discuss your opportunities. 

Platt Wealth Management offers financial plans to answer your important financial questions. Where are you? Where do you want to be? How can you get there? Our four-step financial planning process is designed to be a road map to get you where you want to go while providing flexibility to adapt to changes along the route. We offer stand alone plans or full wealth management plans that include our investment management services. Give us a call today to set up a complimentary review. 619-255-9554.