Time pay for college with my 529 and ESA

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Topic Author
RobG
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Time pay for college with my 529 and ESA

Post by RobG » Sat Mar 07, 2020 11:25 am

My daughter started attending Dartmouth last fall so I'm getting rather large bills. I have a 529 and and ESA for her education, which has about two years of tuition. I also have one for my son with about 2/3 of a year of tuition. I'm not sure if my son will go to college so I'll probably use his 529 for my daughter. Once those are drained I have other resources (appreciated stocks, Roth funds from IRA conversions, I bonds, HSA account and hopefully money I earn (my earnings are entirely unpredictable).

I want to know if there are considerations I haven't thought of before I start cashing the 529s and ESA in.

I understand that the funds must be for "qualified expenses" (https://www.irs.gov/credits-deductions/ ... d-expenses) which appears to be largely tuition and books and not room and board.

I also know I must be careful I leave at least $4000 in qualified expenses so I don't lose the $2500 American Opportunity Tax Credit (https://www.irs.gov/credits-deductions/individuals/aotc). One source of confusion regarding the AOTC is the phrase "If the credit brings the amount of tax you owe to zero, you can have 40 percent of any remaining amount of the credit (up to $1,000) refunded to you." Does this mean that if I overpaid my taxes and am due a refund I would only get $1000 instead of $2500?

I'm a consultant so my income varies from poverty to very good, but with IRA contributions I can probably keep it under $80,000 (Married filing jointly). I don't think income level affects how 529 and ESA should be spent, but it does affect AOTC benefits.

Are there other considerations before I start cashing my 529s and ESAs in?

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[Edit] One other thing that appears to work against creating a 529 or ESA is that Dartmouth and other Ivy league schools give large scholarships that can entirely waive tuition. If I read things right the scholarships reduce the amount of qualified expenses, and if tuition was entirely waived you would have minimal qualified expenses so your 529/ESA would give limited advantage. Is that correct?
Last edited by RobG on Sat Mar 07, 2020 11:31 am, edited 1 time in total.
Stay thrifty my friends.

SchruteB&B
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Re: Time pay for college with my 529 and ESA

Post by SchruteB&B » Sat Mar 07, 2020 11:29 am

RobG wrote:
Sat Mar 07, 2020 11:25 am
I understand that the funds must be for "qualified expenses" (https://www.irs.gov/credits-deductions/ ... d-expenses) which appears to be largely tuition and books and not room and board.
Room and Board is a qualified expense for a 529.

Topic Author
RobG
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Re: Time pay for college with my 529 and ESA

Post by RobG » Sat Mar 07, 2020 11:34 am

SchruteB&B wrote:
Sat Mar 07, 2020 11:29 am
RobG wrote:
Sat Mar 07, 2020 11:25 am
I understand that the funds must be for "qualified expenses" (https://www.irs.gov/credits-deductions/ ... d-expenses) which appears to be largely tuition and books and not room and board.
Room and Board is a qualified expense for a 529.
Thanks. The qualified expenses description explicitly disqualifies room and board, but can I assume you mean that doesn't mean you can't use a 529 to pay for those?
Stay thrifty my friends.

SchruteB&B
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Re: Time pay for college with my 529 and ESA

Post by SchruteB&B » Sat Mar 07, 2020 11:40 am

RobG wrote:
Sat Mar 07, 2020 11:34 am
SchruteB&B wrote:
Sat Mar 07, 2020 11:29 am
RobG wrote:
Sat Mar 07, 2020 11:25 am
I understand that the funds must be for "qualified expenses" (https://www.irs.gov/credits-deductions/ ... d-expenses) which appears to be largely tuition and books and not room and board.
Room and Board is a qualified expense for a 529.
Thanks. The qualified expenses description explicitly disqualifies room and board, but can I assume you mean that doesn't mean you can't use a 529 to pay for those?
The qualified expenses description for what? Pub 970 governs 529 plans and it expressly includes room and board as a QUEE. That’s what I responding to in your post.

DIFAR31
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Re: Time pay for college with my 529 and ESA

Post by DIFAR31 » Sat Mar 07, 2020 11:50 am

RobG wrote:
Sat Mar 07, 2020 11:34 am
SchruteB&B wrote:
Sat Mar 07, 2020 11:29 am
RobG wrote:
Sat Mar 07, 2020 11:25 am
I understand that the funds must be for "qualified expenses" (https://www.irs.gov/credits-deductions/ ... d-expenses) which appears to be largely tuition and books and not room and board.
Room and Board is a qualified expense for a 529.
Thanks. The qualified expenses description explicitly disqualifies room and board, but can I assume you mean that doesn't mean you can't use a 529 to pay for those?
In an effort to thoroughly confuse taxpayers, the IRS has different definitions for the term "Qualified Higher Education Expenses," depending on which tax incentive is being considered. Room and board is not a QHEE for the tax credits; it is a QHEE for 529s. With 529 accounts, an ESA, eligibility for the American Opportunity Credit and a child attending a school that provides generous need-based financial aid, you really need to become familiar with IRS Pub 970.

https://www.irs.gov/pub/irs-pdf/p970.pdf

Chapter 8 covers 529 accounts.
One source of confusion regarding the AOTC is the phrase "If the credit brings the amount of tax you owe to zero, you can have 40 percent of any remaining amount of the credit (up to $1,000) refunded to you." Does this mean that if I overpaid my taxes and am due a refund I would only get $1000 instead of $2500?
The AOTC is partially refundable. The first $1,500 of the credit can only be used to reduce tax liability. The remaining $1,000 of the credit will be paid to the claiming taxpayer even if there is no existing tax liability.

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Re: Time pay for college with my 529 and ESA

Post by abuss368 » Sat Mar 07, 2020 11:54 am

I would rethink using any of your retirement funds for funding college. I watched a PBS program that Jack was on where folks who did that could not retire.

One can finance college but can not finance retirement.
John C. Bogle: Two Fund Portfolio - Total Stock & Total Bond - “Simplicity is the master key to financial success."

Topic Author
RobG
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Re: Time pay for college with my 529 and ESA

Post by RobG » Sat Mar 07, 2020 12:06 pm

Thanks DIFAR31, I figured there must be two definitions of QEEs.

The term "tax liability" is what I still don't understand. Forgive me I am dense and easily confused. Does a person who pays his taxes throughout the year so that he will get a refund at the end of the year have a tax liability? Or did he disqualify himself? The first paragraph of the AOTC document uses the term "amount of tax you owe" which is line 22 on the 1040 and is the total tax (line 15) minus payments (line 18). The second paragraph just uses the word "tax." Ugh.

I'll be getting a huge ACA refund because I had very low income in 2019 but paid for my insurance anyway. Did I disqualify myself from the credit.
Stay thrifty my friends.

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abuss368
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Re: Time pay for college with my 529 and ESA

Post by abuss368 » Sat Mar 07, 2020 12:09 pm

SchruteB&B wrote:
Sat Mar 07, 2020 11:29 am
RobG wrote:
Sat Mar 07, 2020 11:25 am
I understand that the funds must be for "qualified expenses" (https://www.irs.gov/credits-deductions/ ... d-expenses) which appears to be largely tuition and books and not room and board.
Room and Board is a qualified expense for a 529.
Correct. That is my understanding as well.
John C. Bogle: Two Fund Portfolio - Total Stock & Total Bond - “Simplicity is the master key to financial success."

DIFAR31
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Re: Time pay for college with my 529 and ESA

Post by DIFAR31 » Sat Mar 07, 2020 12:15 pm

RobG wrote:
Sat Mar 07, 2020 12:06 pm
Thanks DIFAR31, I figured there must be two definitions of QEEs.

The term "tax liability" is what I still don't understand. Forgive me I am dense and easily confused. Does a person who pays his taxes throughout the year so that he will get a refund at the end of the year have a tax liability? Or did he disqualify himself? The first paragraph of the AOTC document uses the term "amount of tax you owe" which is line 22 on the 1040 and is the total tax (line 15) minus payments (line 18). The second paragraph just uses the word "tax." Ugh.

I'll be getting a huge ACA refund because I had very low income in 2019 but paid for my insurance anyway. Did I disqualify myself from the credit.
The amount of tax you owe is the figure after non-refundable tax credits are applied and before withholding or other payments are taken into account. This number is on line 16 of the 2019 1040. By way of example, if the amount on 1040 line 16 is $1,234, you had $1,500 in withholding or estimated payments through the year, and you are eligible for the $1,000 refundable part of the AOTC, you would be receiving a refund of $1,266. I don't know enough about the ACA to address that part of your situation.

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RobG
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Re: Time pay for college with my 529 and ESA

Post by RobG » Sat Mar 21, 2020 12:15 pm

I did my taxes using Turbo Tax and here is what I found. As mentioned earlier there are two components to the educational credits: a refundable AOTC credit up to $1000, and an additional non-refundable credit up to $1500. In short, the non-refundable credits reduce your taxes, but can't reduce them below zero. Refundable credits are like tax payments

The non-refundable credits are things like the non-refundable part of the AOTC, child tax credit, foreign tax credit, etc. They are subtracted from the tax (line 12a) which is calculated from your taxable income (which you can adjust with an IRA deduction). These credits can't bring the total tax (line 16) to less than zero.

Next step is to deal with the refundable credits which include the $1000 "refundable" AOTC credit and the Obamacare premium tax credit (PTC).

Refundable credits are treated like a tax payment which is subtracted directly from total tax (line 16). Since they are equivalent to tax payments these can bring your tax owed to below zero in the same way an over payment of taxes would. In that case you would be owed a refund.

Simplified, the process goes like this:
Taxable Income = (Total Income) - (IRA contribution) - (Standard Deduction)
Tax = (Taxable Income)*(Tax rate)
Total Tax = (Tax) - (Non-refundable Credits include the $1500 part of the AOTC) (can't be less than zero).
Tax owed (or overpaid) = (Total Tax) - (Payments) - ($1000 AOTC) - (Obamacare PTC) - (other Refundable Credits).

So, to answer my question, even though the PTC caused me to have a tax refund, I was still able to deduct the full $2500 from the tax.

Interestingly enough, if I understand this correctly, your IRA contribution could reduce your income enough to where you won't get the full non-refundable credits. Thus you could get in a spot where IRA contributions actually increases the amount you owe.
Stay thrifty my friends.

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