Mechanics of Paying for college
June 25, 2024 11:28 AM Subscribe
I have some questions about Ibonds, 529s, taxes, and paying for college. Have been trying to find a CPA or someone to help locally but no luck so I'm asking here.
To be clear: I would prefer to work with a local ... person? CPA? about this but I've been trying for three weeks and I can't find anyone locally who is willing to book a couple of hours and have this conversation with me. Either they don't return my call at all or they feel scammy when I talk to them, or they won't work with us because we are not a client for tax prep or investments. So, now I'm asking here.
In the early 2000s my mother bought some US Treasury I bonds to fund my child's college education. Now its time to cash some of them out to pay for the first semester, but she was surprised to learn that she will be responsible for the disbursement to be taxed as income, since the college student is not her dependent.
We've been told informally that she should transfer the Ibonds to me (the parent) through Treasury Direct, and then I should open a 529 for the student (who is still under 18 for a few weeks), and so long as we put the proceeds from the Ibond sale into the 529 within 60 days the proceeds will be tax free and then we can pay the college out of the 529.
Except --
1. Choosing a 529 seems much harder than it should be? Apparently they have fees? Honestly the whole 529 thing is utterly confusing and overwhelming to me but there doesn't appear to be a person I can talk to to help me choose one. For these purposes, does any 529 work?
2. Is the 529 step even necessary? It seems like, so long as the Treasury Direct account is set up for both my spouse and I, that the interest from any bonds is not taxable so long as we pay it directly to the school? (But then what if the bond amount we cash is less more than we need to pay the school? Do we just pay ahead and that counts?)
I'm sorry to sound like such an idiot about this, but the whole 529 step has thrown me for a loop and the August 15 payment deadline to the school is looming.
Thanks for any help or direction you can provide.
To be clear: I would prefer to work with a local ... person? CPA? about this but I've been trying for three weeks and I can't find anyone locally who is willing to book a couple of hours and have this conversation with me. Either they don't return my call at all or they feel scammy when I talk to them, or they won't work with us because we are not a client for tax prep or investments. So, now I'm asking here.
In the early 2000s my mother bought some US Treasury I bonds to fund my child's college education. Now its time to cash some of them out to pay for the first semester, but she was surprised to learn that she will be responsible for the disbursement to be taxed as income, since the college student is not her dependent.
We've been told informally that she should transfer the Ibonds to me (the parent) through Treasury Direct, and then I should open a 529 for the student (who is still under 18 for a few weeks), and so long as we put the proceeds from the Ibond sale into the 529 within 60 days the proceeds will be tax free and then we can pay the college out of the 529.
Except --
1. Choosing a 529 seems much harder than it should be? Apparently they have fees? Honestly the whole 529 thing is utterly confusing and overwhelming to me but there doesn't appear to be a person I can talk to to help me choose one. For these purposes, does any 529 work?
2. Is the 529 step even necessary? It seems like, so long as the Treasury Direct account is set up for both my spouse and I, that the interest from any bonds is not taxable so long as we pay it directly to the school? (But then what if the bond amount we cash is less more than we need to pay the school? Do we just pay ahead and that counts?)
I'm sorry to sound like such an idiot about this, but the whole 529 step has thrown me for a loop and the August 15 payment deadline to the school is looming.
Thanks for any help or direction you can provide.
According to this IRS publication, to get the education deduction, "The bond must be issued either in your name (as the sole owner) or in the name of both you and your spouse (as co-owners)." So your scheme would work only if you were somehow able to get the bond reissued in your name, and I don't think that's an option.
The tax bill is going to depend on the total earnings from the bonds and your mother's other income so will probably be a small fraction of the proceeds. For example, if the bonds doubled over that period and your mother is in the 22 percent income tax bracket, then she will pay 11 percent of the value in taxes. (To get an idea of her income tax rate, here are the brackets.)
If she has relatively low income and the bonds are now worth a lot, one way of minimizing taxes is for her to sell a portion each year so that the income from the bonds doesn't push her into a higher tax bracket. For example, the 12% bracket for a single person goes to $47,150; then it jumps to 22%, then to 24% above $100,525. Depending on her income and how much the bonds appreciated, she might be able to cut her taxes roughly in half by cashing in only part over several years.
If you did have the bond issued in your name, I don't see how depositing it in a 529 would help. There are two benefits of 529: returns are not taxed, and in some cases state tax benefits. You're paying now, so there's basically no returns to be taxed - you won't earn much in a month. It looks like you're in Maine. There's $1000 max annual deduction per student, and a 6-7 percent tax rate, so you'd be saving about $60 a year, which is probably not worth the fuss.
posted by Mr.Know-it-some at 12:29 PM on June 25, 2024
The tax bill is going to depend on the total earnings from the bonds and your mother's other income so will probably be a small fraction of the proceeds. For example, if the bonds doubled over that period and your mother is in the 22 percent income tax bracket, then she will pay 11 percent of the value in taxes. (To get an idea of her income tax rate, here are the brackets.)
If she has relatively low income and the bonds are now worth a lot, one way of minimizing taxes is for her to sell a portion each year so that the income from the bonds doesn't push her into a higher tax bracket. For example, the 12% bracket for a single person goes to $47,150; then it jumps to 22%, then to 24% above $100,525. Depending on her income and how much the bonds appreciated, she might be able to cut her taxes roughly in half by cashing in only part over several years.
If you did have the bond issued in your name, I don't see how depositing it in a 529 would help. There are two benefits of 529: returns are not taxed, and in some cases state tax benefits. You're paying now, so there's basically no returns to be taxed - you won't earn much in a month. It looks like you're in Maine. There's $1000 max annual deduction per student, and a 6-7 percent tax rate, so you'd be saving about $60 a year, which is probably not worth the fuss.
posted by Mr.Know-it-some at 12:29 PM on June 25, 2024
I'm not an expert either, but here are some things to consider:
1) If your mother transfers the bonds to you, you might need to worry a bit about gift taxes. In 2024, she can transfer $18,000 to each of you and your spouse (so $36,000 total) with no tax concerns. Above that, it gets a bit more complicated, with filing requirements and possible impacts on later estate tax stuff for big estates. This is probably going to be relevant for most paths of getting that money from her to your child in some way this year.
1.5) If your mother transfers funds to your child, there's also a "generation skipping transfer tax" (GSTT) with similar exclusions. I know less about that.
2) Reissuing the bonds is possible, but it appears to trigger the original owner paying tax on the interest earned to that point: "Will I have to pay taxes when you reissue the bond?" from TreasuryDirect.
3) This site that I have not vetted (ugh, sorry, but maybe it's useful) suggests [search for "Change 529 Plan Beneficiary"] that your mother could cash out the bonds into a 529 she opens for herself, owe no taxes on that interest, and then change the beneficiary to your child later. I think there would still be gift tax and GSTT considerations, but it could avoid the income tax on the interest at least. Definitely something that would require an expert to help with, so I just suggest it as a possible fix to investigate once you connect with one.
4) Everything I'm reading suggests there is no age requirement for the beneficiary of a 529 account, so your child's impending birthday doesn't look like an issue there.
In summary: If your goal is to avoid anyone paying income tax on the bond interest, then it looks like reissuing the bonds to you won't help. One way to avoid that tax may be for your mother to open a 529 for herself, then change the beneficiary to your child later, but that would definitely require an expert. There are likely to be gift tax implications no matter how you wrangle it, but those probably aren't big unless your mother's estate is huge (>$10M).
I'm so sorry you're dealing with this. Tax and estate and financial stuff gets so complicated and arcane and stressful sometimes. I'm also sorry that I'm not an expert and might be giving you wrong advice. I hope some of that is helpful at least, though.
posted by whatnotever at 2:58 PM on June 25, 2024 [1 favorite]
1) If your mother transfers the bonds to you, you might need to worry a bit about gift taxes. In 2024, she can transfer $18,000 to each of you and your spouse (so $36,000 total) with no tax concerns. Above that, it gets a bit more complicated, with filing requirements and possible impacts on later estate tax stuff for big estates. This is probably going to be relevant for most paths of getting that money from her to your child in some way this year.
1.5) If your mother transfers funds to your child, there's also a "generation skipping transfer tax" (GSTT) with similar exclusions. I know less about that.
2) Reissuing the bonds is possible, but it appears to trigger the original owner paying tax on the interest earned to that point: "Will I have to pay taxes when you reissue the bond?" from TreasuryDirect.
3) This site that I have not vetted (ugh, sorry, but maybe it's useful) suggests [search for "Change 529 Plan Beneficiary"] that your mother could cash out the bonds into a 529 she opens for herself, owe no taxes on that interest, and then change the beneficiary to your child later. I think there would still be gift tax and GSTT considerations, but it could avoid the income tax on the interest at least. Definitely something that would require an expert to help with, so I just suggest it as a possible fix to investigate once you connect with one.
4) Everything I'm reading suggests there is no age requirement for the beneficiary of a 529 account, so your child's impending birthday doesn't look like an issue there.
In summary: If your goal is to avoid anyone paying income tax on the bond interest, then it looks like reissuing the bonds to you won't help. One way to avoid that tax may be for your mother to open a 529 for herself, then change the beneficiary to your child later, but that would definitely require an expert. There are likely to be gift tax implications no matter how you wrangle it, but those probably aren't big unless your mother's estate is huge (>$10M).
I'm so sorry you're dealing with this. Tax and estate and financial stuff gets so complicated and arcane and stressful sometimes. I'm also sorry that I'm not an expert and might be giving you wrong advice. I hope some of that is helpful at least, though.
posted by whatnotever at 2:58 PM on June 25, 2024 [1 favorite]
My understanding is that with the new 2024-25 FAFSA changes there are advantages for the 529 to be in the grandparent’s name.
posted by oceano at 3:07 PM on June 25, 2024
posted by oceano at 3:07 PM on June 25, 2024
You might do better with this question on the bogleheads forum - it is more focused on personal finance.
In general, I think the strategy that had been suggested to you is outlined in this article. You can cash a savings bond and roll the proceeds into a 529 without paying tax on the gains. The article suggests that there is a way for a grandparent to do the same, but it is somewhat technical/complex. It sounds like your mom could open a 529 in her own name, sell the bonds and put the proceeds into the 529 - thus avoiding the income tax on the bonds - and then later change the beneficiary of the 529 to your child and use the money to pay for school. In this model, the 529 avoids the whole issue of having to have the bonds reissued to you. Maybe ask on bogleheads if anyone has done this and how.
Good to see a longtime username!
posted by Mid at 8:06 PM on June 25, 2024 [2 favorites]
In general, I think the strategy that had been suggested to you is outlined in this article. You can cash a savings bond and roll the proceeds into a 529 without paying tax on the gains. The article suggests that there is a way for a grandparent to do the same, but it is somewhat technical/complex. It sounds like your mom could open a 529 in her own name, sell the bonds and put the proceeds into the 529 - thus avoiding the income tax on the bonds - and then later change the beneficiary of the 529 to your child and use the money to pay for school. In this model, the 529 avoids the whole issue of having to have the bonds reissued to you. Maybe ask on bogleheads if anyone has done this and how.
Good to see a longtime username!
posted by Mid at 8:06 PM on June 25, 2024 [2 favorites]
By the way, you can choose any 529 plan in any state for your purposes, because the main goal is to avoid federal income tax on the cash-out of the bonds (not state-specific deductions). Look for a plan that is easy to move money in/out and has low fees. People mention Utah and Nevada as being good. Nevada is run by Vanguard, which is good.
posted by Mid at 5:20 AM on June 26, 2024
posted by Mid at 5:20 AM on June 26, 2024
We lived in Massachusetts when we set up a 529. The tax deductible contribution each year was comically low ($2000 for married filing jointly) and it had to be in the MA plan managed by Fidelity, but we liked the Utah plan better based on online advice.
So we set up two.
We contributed the max $2000 to the MA plan to get the tax deduction and then the rest to the Utah plan. That way we get the tax benefits of contribution, but more of our money is in the plan we like better, and now our money is slightly more diversified than it would've been otherwise.
posted by msbrauer at 9:31 AM on June 26, 2024
So we set up two.
We contributed the max $2000 to the MA plan to get the tax deduction and then the rest to the Utah plan. That way we get the tax benefits of contribution, but more of our money is in the plan we like better, and now our money is slightly more diversified than it would've been otherwise.
posted by msbrauer at 9:31 AM on June 26, 2024
I hope you have received the advice you needed. You didn't mark your question "resolved." If these comments weren't enough, please consider a financial planner. A planner can help you with this issue and all the other issues. I'll be glad to recommend mine if you'll MeMail me.
posted by JimN2TAW at 2:23 PM on June 26, 2024
posted by JimN2TAW at 2:23 PM on June 26, 2024
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I can't comment as to whether this transfer to you and putting in a 529 makes sense, but...
Your state 529 might have tax benefits that make it desirable. California (where I live) does not (I got this information from the Vanguard website, but it's all out there on the intertubes). If your state offers a tax advantage then it's probably a good idea to go with them. If not, you can, in theory, pick any state's 529 plan. Vanguard defaults to the Nevada plan because... I don't know. Lowest fees, probably. Vanguard is stupid about low fees.
Your profile says you are in Maine. Maine's NextGen 529 has a state tax benefit and reasonably low fees.
If you want to open a 529 and shove the bond money in there, that seems like, at the very least, a not bad option. You could do worse.
posted by It's Never Lurgi at 12:12 PM on June 25, 2024