Financial Advice for Retirement, Social Security, IRAs and Estate Planning

A Loophole for 529 Plan Losses

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Many people who saved for college through 529 savings plans face substantial losses in their accounts. There is a silver lining in the tax law, and it is one reason 529 plans are among the best ways to save for education.

Income and gains earned by the 529 account are sheltered. If the account balance is used to pay for qualified education expenses, the distributions are tax free.

What about losses? Generally losses in a tax-deferred account are not deductible. But an exception applies to IRAs, annuities, and 529 plans. If you close the account, withdrawing all the funds, the investment loss is deductible as a miscellaneous itemized deduction on Schedule A. To the extent the total miscellaneous itemized expenses exceed 2% of adjusted gross income, it is deductible.

Example. Max Profits contributed $75,000 to a 529 for his grandchild. The account now is worth $50,000. Max closes the account. Max can deduct $25,000 as a miscellaneous itemized expense on Schedule A. To the extent the $25,000 loss plus Max’s other miscellaneous itemized expenses exceed 2% of his AGI, there is a deduction against adjusted gross income.

The deduction is not allowed against the alternative minimum tax. If you deducted contributions against state income taxes, you might have to recapture all or some of the deductions. Before re-investing in another 529 plan, wait at least 61 days. The contribution to the 529 plan was a gift and probably was sheltered from gift tax by the annual exclusion and perhaps by the rule that allows you to take five years’ worth of annual exclusion in one year for 529 plan contributions. Consult your estate planner on how to handle this and any new contributions.

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