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Tuition Prepayment Is Risky When Using A 529 Plan

Tuition Prepayment is Risky When Using a 529 Plan

You may think that pre-paying college tuition with a 529 college savings plan is a cost-efficient way to fund college expenses and avoid future college inflation. However, the Internal Revenue Service (IRS) may disagree. We’ll explain why in a moment.

First, a little background on college costs and inflation. As your student returns to campus and the new year’s tuition bill comes due, you are either already aware of the fact, or will quickly learn, that college inflation costs are exceeding normal economic inflation. Whether your student attends a public or private college/university, all institutions have raised their tuition and fees significantly in the past year. In fact, according to The College Board, average tuition and fees for in-state students at public,four-year institutions increased by 4.8% from 2012 to 2013, and average tuition and fees at private, four-year institutions increased by 4.2%. Talk about sticker shock for parents!

Historical data further supports the fact that college inflation has outpaced normal inflation. The College Board reports that over the past decade (school year 2002-03 to 2012-13), tuition, fees, and room and board at public, four-year institutions rose an average of 3.8% per year beyond normal inflation. During the same time, costs at private, four-year institutions rose an average of 2.3% per year above normal inflation.

With college inflation continuing to rise significantly, a university’s offer to let you prepay tuition during your child’s freshman year and avoid rising tuition costs may sound quite appealing. Prepayment can lead to significant savings because you beat rising inflation costs. However, these savings could be negated by stiff penalties if your payment comes from a 529 college savings plan.

Why? The IRS may not consider tuition prepayment a “qualified higher education expense.” That’s because in general, the IRS operates on a calendar year. This means money distributed from a 529 plan in a given year must be matched to expenses in the same year. The IRS is so meticulous that even withdrawing money in December to pay tuition in January may not be deemed a qualified expense.

So, how would the IRS potentially look at using a distribution from a 529 in the current year to pay for future years’ expenses?  The answer is it  likely would not meet IRS guidelines of matching expenses and payments to the same calendar year, making part of the distribution non-qualified. If a 529 plan distribution is considered non-qualified by the IRS, you could be subject to taxable income and a 10% tax penalty on the earnings portion of the distribution. It’s not wise to willingly subject yourself to these extra taxes, since tax-free growth is one of the benefits of having a 529 plan in the first place.

In general, prepaying college tuition can be a great way to avoid inflation. However, we strongly suggest that you consult with your tax professional before using a 529 plan to do so.

 

Important Disclosure Information

Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request. This presentation is not a substitute for personalized advice from RegentAtlantic.  This information is current only as of the date on which it was sent.  The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic.  Descriptions of RegentAtlantic’s process and strategies are based on general practice and wemay make exceptions in specific cases.

Please remember that RegentAtlantic does not provide tax advice.  Please speak with a tax professional of your choosing prior to implementing any of the strategies discussed in this article.

Important disclosure information

Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.

Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.

This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.

RegentAtlantic does not provide legal or tax advice. Please consult with a legal and or tax professional of your choosing prior to implementing any of the strategies discussed in this article.

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