total contributions made without regard to whether the contributions are made to a single account or more than one account. Do Contributions to 529 college savings and tuition programs qualify as a deduction? , Ill. Department of Revenue, https:// www2.illinois.gov/rev/questionsandan- swers/Pages/206.aspx. Contributions to an account are considered a gift from the contributor to the designated beneficiary and, even though the plan holder has control over the account by being able to direct investments or change the ben- eficiary, are generally excludable from the account owner’s taxable estate. 26 U.S.C. § 529(c)(2). The question for each borrower is two- fold: (1) when to take a 529 distribution to pay off student loans, keeping in mind the $10,000 lifetime limit; and (2) whether they should take a 529 distribution at the expense of the interest deduction, which is a federal deduction at rates higher than Illinois’ income tax rate of 4.95%. The choice for higher-earning borrowers is easy because the interest deduction phases-out and is then unavailable as one has more income. Under pre-existing tax law, indi- viduals who have paid interest on qualified education loans may claim an above-the- line deduction for such interest expenses subject to a minimum annual deduction limit of $2,500 with the deduction phased- out (for individuals, modified Adjusted Gross Income between $70,000 and $85,000; for married taxpayers, modified AGI between $140,000 and $170,000). If a borrower is under the income thresholds, the interest rate deduction is almost always preferable before taking the SECURE Act 529 distribution. Either the benefit of deducting interest from income taxed at the higher federal rate will outweigh deducting both interest and principal at Illinois’ 4.95% income tax rate, or the borrower will eventually earn too much to take the interest rate deduction. At that point, they would want to take advantage of the new SECURE Act distribution for lack of any other options. Regardless of a young attorney’s income or station in life, there is no reason not to take advantage of this benefit. The below chart shows how in just five years of modest
Even with the suspension of payments, borrowers should consider setting-up and funding a 529 plan now. If the government later forgives student debt, 529 account holders can change the beneficiary to cur- rent or future children, grandchildren, and other family members. The more remote the family member beneficiary, the more likely the taxpayer will need to consider additional tax planning, including the federal generation-skipping tax. Although this strategy and the examples provided herein show little downside, nothing in this article is intended as legal or financial advice. Please consult your tax and legal advisors before implementing any strategy discussed in this article. Further, as 2020 is the first year in which such a deduction is available, the authors cannot predict the response of tax authorities to the tactics outlined herein. Lance J. Sherry, JD, CFP® is a Wealth Plan- ner and Vice President at Fifth Third Private Bank. Lance specializes in generational wealth transfer strategies and income and estate tax planning for Ultra High Net Worth indi- viduals and their families.
contributions to a 529 Plan, the borrower can generate an effective return of roughly 26%, assuming a 6% investment gain. Even with more modest returns or even small losses, the plan has little downside because of the immediate 4.95% Illinois state income tax deduction for each 529 contribution. In the scenario outlined in the nearby table, $8,250 of investment pays off $10,000 of debt. Even if the borrower puts in $10,000 today and withdraws it tomorrow with no investment returns, the borrower still gets a 4.95% ($495) income tax deduction for the year of contribution. At worst, the borrower has roughly offset a year of interest on $10,000 of their debt. Beyond administrative effort and investment monitoring (and barring siz- able investment losses), there is negligible downside to this strategy. The table shows a potential example of deploying the $10,000 SECURE Act 529 contribution deduction over five years. Given more time, of course, the contributions to meet the $10,000 limit are reduced. Borrowers who anticipate increased income but can still claim the interest rate deduction, for the time being can use the suggested strategy to accumulate invest- ment gains in a 529 Plan for the day when they are no longer eligible for the interest deduction. Conclusion Whether Congress intended it or not, the SECURE Act allows savvy borrowers to utilize investment returns and state income tax deductions to offset their student loan burdens. While the CARES Act has sus- pended federal student loan interests and payments for the time being, these debts have not been forgiven and may never be.
Robert L. Schur is an associate at Hamilton Thies & Lorch LLP specializing in estate planning and estate and trust administration for clients across the wealth spectrum. He is licensed