<p>what are the benefits of starting one now?</p>
<p>if your state is one that offers a tax deduction against state income taxes, then definitely worthwhile. Otherwise, not so much.</p>
<p>Also some not-so-great consequences. If you use 529 funds to pay for tuition, you then can’t take the AOC on your taxes. It’s unlikely any increase because of interest on the 529 funds will be greater than the AOC.</p>
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<p>Well… kinda. You can’t claim the AOC on qualified expenses that were paid with 529 dollars. But if you have qualified expenses left over after using 529 funds, you absolutely can still claim the AOC for those expenses. And remember, QTPs (529 plans) and the AOC use different definitions of qualified expenses. 529 dollars can be used for room and board, while those expenses are not qualified for purposes of the AOC.</p>
<p>The biggest drawback to opening a 529 account for a current student is that you won’t have a lot of time to take advantage of the tax free growth, which will probably be minimal anyway because it’s likely that the funds will be allocated to a relatively conservative investment, given the anticipated timeline for use.</p>
<p>As bluebayou states, at this point a state tax deduction, if available, is probably the best reason to open an account for a student already in college.</p>
<p>Or, if you have savings bonds (EE or I bonds) and you want to have an education tax exemption for the interest and use it to pay for room & board. Otherwise, the savings bonds can only be used tax free for tuition and books I believe. </p>
<p>As long as you pay $4K/year out-of-pocket (or with loans) towards tuition, and you otherwise meet the income/eligibility requirements, you can get the American Opportunity Credit. Other tuition, fees, books & room & board can be paid from the 529.</p>
<p>Financial experts, please correct me if I’m wrong, but only the income generated by the 529 funds (dividends, interest) cannot be used toward claiming the AOC. If you put $2000 in the fund (after tax money) and the fund generated $50 in dividends (money not taxed), then $1,950 can still be applied to the AOC. In this case, not a problem as the money put in while the child in in college will make very little income. You can’t apply tax free money toward the AOC. The principle is not tax free money, but the interest and dividends are. </p>
<p>^^
Yes, I believe that is correct. If a 529 distribution that included no earnings was used to pay qualified expenses for which the AOC was claimed, there would be no tax owed on the 529 distribution and the AOC would be allowed.</p>
<p>Using your numbers above, let’s assume that the cost of attendance is $5000 (tuition and fees only), the entire 529 balance of $2050 (principal plus earnings) is used to pay this cost, and the AOC is claimed on $4000 of qualified expenses. There would be $25.61 in taxable earnings, the 10% penalty would be waived, and you would also have a tax credit of $2500.</p>
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<p>I don’t think that’s right.The example in IRS Pub 970 page 58, coordinating 529 distributions with the AOC, shows this. It’s the reverse of your thinking GTalum. The AOC is subtracted from QEE first, then if the full 529 distribution results in an excess distribution the earnings part of the excess is taxable. If there were no earnings then there would be no tax but I think you’d still have to go through the extra stuff on the tax return to get to that point because you have an excess distribution.</p>
<p>Trying to clarify, you can’t just reduce QEE by the $50 earnings and say you have that much for the AOC. Trying to make it simple, if AOC QEE is $2050 and there’s no R&B in the picture and you take a $2050 529 distribution, you can’t say $2000 is available for the AOC. If you take a $2000 AOC, with a $2050 529 distribution, then you have a $2000 excess distribution and have to figure the taxable portion of that.</p>
<p>Seems like a lot of trouble and risk of losing a tax credit to MAYBE get a small amount in tax free earnings.</p>
<p>The numbers being used here for examples are very tight to illustrate some points. For most folks whose kids don’t get very large scholarships or need-based grants relative to QEE, there is enough QEE to go around for the AOC, tax-free distributions etc., especially considering R&B is QEE for 529 distributions. But I think whether there is a state tax deduction for contributions is the only thing that would make for a significant advantage in starting a 529 this late.</p>
<p>^Agree. You can pay $2000 out of pocket toward tuition and get a $2000 AOC tax credit, and pay the rest with 529 funds. The extra $2000 you could pay only gets you $500 more credit. But it may not be worth it at this point.</p>
<p>Thanks for the clarification AnnoyingDad, I had to sleep on it to understand. It still doesn’t seem “right” or “fair” that $2,000 after tax money used in our example can be taxed again. But you are correct, most of us have enough expenses. I applied 529 expenses to room and board to make it easier. </p>
<p>I felt the 529 contributions to our account while the kids were in college for the state tax break. I got 10% back in state taxes for the money I put in and I could put up to $5,000. There were no restrictions as to when I could draw the money out of the account. I suspect it was due to people like me that the state ended the tax break for 2014. </p>
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<p>It’s not taxed again. Only the earnings are taxed, at a ratio that corresponds to that part of the 529 distribution that is used for the AOC and/or covered by nontaxable scholarships/grants.</p>
<p>Let’s say that your total cost of attendance ('qualified education expenses") is $10,000 in tuition and fees. If $4,000 of that is used for the AOC and the student received $2,000 in nontaxable scholarship dollars, the “adjusted qualified education expenses” are $4,000 ($10k minus $4k minus $2k). If you took a 529 distribution of $8,000 that was made up of $6,000 in after-tax contributions and $2,000 in earnings, you would be taxed on $1,000 of the earnings, because half of the distribution went for expenses that exceeded the adjusted qualified education expenses.</p>
<p>MiddKid has it. My point was you can’t just use the earnings part to determine whether you have an excess distribution, you have to use the full distribution amount in determining whether you have to report it. But the distribution has a basis and an earnings component and when you go through reporting the excess distribution amount on the tax forms, only the earnings portion of the excess distribution amount will be taxed. And the penalty won’t apply if the reason you had an excess distribution was because you used expenses for the AOC or because of tax-free scholarships.</p>
<p>Thanks for the explanation MiddKid. I think I got it. </p>
<p>why did I go to art school? </p>
<p>FYI…</p>
<p>Q10. Who can claim the American opportunity tax credit?</p>
<p>A. Generally, a taxpayer whose modified adjusted gross income is $80,000 or less ($160,000 or less for joint filers) can claim the credit for the qualified expenses of an eligible student. The credit is reduced if a taxpayer’s modified adjusted gross income exceeds those amounts. A taxpayer whose modified adjusted gross income is greater than $90,000 ($180,000 for joint filers) cannot claim the credit.</p>