Money Talk

Personal Finance Q&A: 529 plans vs. education tax breaks

Money Talk
If you 'file and suspend' Social Security benefits, what happens to those funds if you die before 70?

Dear Liz: You recently mentioned in your column that you can't use any of the three education tax breaks — the American Opportunity Credit, the Lifetime Learning Credit or the tuition and fees deduction — for expenses paid with 529 college savings plan money. This has me wondering if those 529 plans are really worth it.

Wouldn't you have to have a really large amount invested to have enough earnings to make it worth not taking one of the credits?

Answer: If college were cheap, that might be a problem. But most people have far more college expenses than they can write off on their tax returns.

The average net price for one year at a four-year college — the published cost minus free financial aid such as grants and scholarships — was just under $13,000 last year, including tuition, fees, room and board. The average net price was around $6,000 at two-year public colleges and $23,550 at private four-year schools.

Many people pay a lot more, as the sticker prices at colleges continue to rise.

As mentioned in the previous column, the three available tax breaks are mutually exclusive, so you can't take more than one in any given year.

The most generous credit, the American Opportunity Credit, reduces taxes dollar-for-dollar for the first $2,000 of college expenses and then by 25% of the next $2,000 — for a total of $2,500 per student.

If your qualified education expenses exceed $4,000, as they probably will, those tax-free 529 plan withdrawals will come in handy.

Dear Liz: You've been writing about the "file and suspend" option that allows you to delay taking Social Security while still reserving the ability to get a lump sum if you later change your mind.

If I file and suspend but choose not to take a lump sum before my benefit maxes out at 70, what happens to those funds? What happens to those funds if I die before 70?

Answer: Remember that Social Security is a pay-as-you-go program. The Social Security taxes you pay aren't piled up in some kind of account, waiting for you to retire. Your taxes pay current retirees' benefits, just as future workers' taxes will pay yours.

When you delay starting Social Security, you're rewarded with a potentially larger check each year you put off claiming until age 70. Your benefit grows by about 7% each year between age 62 and your full retirement age, which is currently 66.

Between full retirement age and 70, your benefit grows at 8% each year in what's called "delayed retirement credits."

If you file and suspend at your full retirement age, then change your mind, you can get a lump sum equal to all those checks you passed up since you filed. However, you lose the 8% delayed retirement credits you could have otherwise claimed.

Your benefit is reset to the lower amount you would have received at full retirement age, and that's the benefit on which all future cost-of-living calculations would be made.

Should you die after filing and suspending, your surviving spouse would be able to benefit from those delayed retirement credits. His survivor's benefit would be equal to what you could have claimed as of the date of your death.

Dear Liz: I started Social Security at 62 and did the spreadsheet myself showing the break-even point. I would have to be 80 before the graphs even cross.

You, and others, have to stop that business about waiting on Social Security if you can. My own mother lived to 90 and it is about quality of life, not collecting lots from the government.

Answer: Exactly. And since you have longevity in the family, you especially should have paid better attention to the message about the importance of delaying benefits.

If your mother started benefits at 62, or ended up living on a survivor's benefit from a husband who started early, then her checks were 30% to 50% smaller than they could have been. That difference can be especially crucial in a person's later years, when she's far more likely to have outlived her other assets and need the additional money.

Remember that the decision to claim Social Security is separate from the decision to retire. People can retire early and draw from other accounts while putting off Social Security to maximize their checks.

Most people who try to do the math on spreadsheets fail to factor in the effects of inflation and taxes, among other factors.

You can get better calculations from one of the free calculators, such as the ones at AARP and T. Rowe Price. You can find a more robust calculator for about $40 at MaximizeMySocialSecurity.com and SocialSecurityChoices.com.

Another option is to read the recent bestseller published by Simon & Schuster: "Get What's Yours: The Secrets to Maxing Out Your Social Security."

Questions may be sent to Liz Weston, 3940 Laurel Canyon, No. 238, Studio City, CA 91604, or by using the "Contact" form at asklizweston.com. Distributed by No More Red Inc.

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