As a new attending physician, you are probably eager to begin saving, thanks to your new job’s higher income. But you might not be sure where to start. One of the first and most common goals for young physician parents is to start putting away money for their child’s future, most specifically their child’s college education.
529 plans are a great place to start given their great tax benefits. We’ll review how each of the most relevant tax benefits work for new attendings so you can determine if a 529 plan is the right strategy for you.
Tax-Free Growth and Withdrawals
In a 529 plan, contributions are made with after-tax dollars. For example, the money in your checking or savings account is considered after-tax.
These after-tax contributions made to the 529 plan can then be invested. Historically, money invested in a well-diversified stock market portfolio, over longer periods of time, have experienced compounding growth. The growth of these investments does not get taxed as it remains in the 529 account. That’s a huge benefit!
Then, when using the 529 to pay for qualified expenses, withdrawals come out tax free. Tax-free withdrawals are a beautiful thing. Especially since these distributions typically happen during some of your highest earning years, when your kids are in college.
If 529 plan savings are not used for qualified expenses, individuals need to be aware of the federal taxation and penalties that can be triggered.
Example: Assume Rebecca & David started saving for their daughter’s college when she entered kindergarten. After 13 years of saving $500 per month into a 529 plan, assuming a growth rate of 7%, they would have approximately $48,600 worth of growth in the 529 plan*. This growth would all be tax-free, if used towards qualified expenses. There total account balance, including contributions, would be around $126,600 .
State Income Tax Deductions
If you live in a state that offers a tax deduction for 529 contributions, you should strongly consider taking advantage of it. Each state has different tax treatments on 529 plans, and almost every state offers their own version of a 529 plan. But only a handful of states will offer a state income tax deduction for contributions made to a 529 plan. Most of these states require the contribution be made to their state’s specific plan. It’s very important to understand the requirements for receiving any tax benefits given by your state. The Panoramic team can help you determine if your state qualifies, otherwise you can learn more here.
For example, the state of New York offers a tax deduction in the year that you contribute, but you must use the New York 529 plan to receive the state tax benefit. You must also work in NY and pay NY state taxes. It’s also subject to limitations on the contribution amount, depending on your situation.
California, on the other hand, offers no state tax benefit for contributing to a 529 plan.
If you live in a state that offers tax benefits, this can further enhance the value of using a 529 plan.
Here are some questions you may want to answer as you think about the tax benefits of which state’s 529 plan you enroll in:
- Does the state we currently reside in have a 529 plan that offers any state tax benefits or incentives?
- What state will we live in during the years we save the most into the 529 plan?
- Will we live in another state between now and our child’s college age? If so, what state, and what are that state’s rules on 529 plans?
Flexible Tax Benefit – Jumpstart Retirement Savings
There is sometimes a concern among young attendings that they’ll save too much into their child’s 529 account. The concern goes something like, “what if my kid ends up not going to that expensive Ivy League school? Or what happens if they receive scholarships and only use half of the 529?”
To relax the worries of saving “too much” into a 529 account, there’s a flexible tax benefit that allows 529 accounts to be rolled into your Child’s Roth IRA. This is a significant benefit that provides you an opportunity to jumpstart your child’s retirement savings.
There are several requirements you must fulfill when doing a rollover from a 529 to a Roth IRA. It’s very important to be aware of these rules, and it’s something that we regularly help our clients navigate. Some of these requirements include (as of 2023):
- The 529 plan must have been opened for 15 years.
- The amount rolled over must have been in the 529 account for at least 5 years.
- There is a lifetime cap of $35k for rollovers.
- The annual rollover amount is limited to the income of the 529 account beneficiary or the annual Roth IRA contribution limit (whichever is less).
Going back to Rebecca & David. Let’s say their daughter graduates’ college and has $13,000 left over in her 529 plan. Because their daughter is finished with her education, David & Rebecca can consider rolling this 529 money over into their daughter’s Roth IRA.
Tax Savings Example
Continuing with Rebecca & David’s 529 savings example. Remember, they would end up having just over $126,000 in their daughter’s 529 plan when she reaches college age. Just for comparison, that would be enough to pay for four years of in-state tuition at UCLA, in today’s dollars.
The growth on their savings in this example is equal to $48,000, which never got taxed because Rebecca & David used the funds for qualified expenses.
Had Rebecca & David saved instead to a traditional taxable investment account, their $48,000 of growth would be subject to long-term capital gains tax rates. This means their 529 plan strategy has saved them approximately $7,200 – $9,600 in taxes (assuming either a 15% or 20% long-term capital gains tax rate).
They also have the opportunity, if they decide, to rollover any excess savings into their daughter’s Roth IRA. This only furthers the tax savings on their family’s wealth.
The 529 plan potentially offers great tax benefits to young attending families who are looking to save for their child’s future education. It should be strongly considered as a part of any young attending family’s financial plan.
Panoramic Financial Advice has helped hundreds of young physicians’ plan and think about saving for college. If you’d like to schedule a complimentary consultation, please click “Work With Us” at the top.
*Investment returns are not guaranteed. Investing in securities involves risks, including the potential for loss of principal. Estimate is for illustration purposes only, is based on annualized returns of 7%. (i=.5833%, n=156, pv=0, pmt=500; fv=126,661), and is not intended to be representative of any specific investment or strategy.
**UCLA tuition & fees for 2023-2024 cohort is equal to $18,197. https://sa.ucla.edu/RO/Fees/Public/public-fees?year=2023-2024&term=Annual°ree=Undergraduate%20cohort%202023-24
The foregoing content reflects the opinions of Panoramic Financial and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Panoramic Financial does not give tax or legal advice. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.