One More Reason to Fund 529 Plans—a 529 Plan UPDATE

School is back in session. For those of you with children (or grandchildren), the pressing question quickly becomes “how best to pay for it?” We have written several articles over the years regarding the benefits of 529 College Savings plans. Such benefits include tax advantages, flexibility, control, and estate planning opportunities. The recent Tax Cut and Jobs Act of 2017 has added another: 529 plans can now be used to pay for K-12 tuition.

Over twenty years ago, Congress established legislation creating “Qualified Tuition Programs” (now commonly called “529 plans”) in an effort to encourage Americans to save for college. Up until this year, qualified withdrawals from these plans must have been used for qualified higher education expenses. The recent tax reform changed this. As of 2018, 529 plan assets can also be used to pay for up to $10,000 annually per beneficiary (student) in tuition expenses for attendance at public, private or religious K-12 schools. Note that there is no such annual limit for qualified higher education expenses.

The $10,000 annual K-12 cap is a per-beneficiary limit, not a per-plan limit. For example, consider a high school student who is the beneficiary of separate plans: one owned by her mother, the other by her grandfather. The student cannot receive $10,000 towards her private school tuition from each plan. She is limited to $10,000 in total distributions from both plans during the taxable year. K-12 distributions in excess of $10,000 will be treated as non-qualified expenses. More on the treatment of funds withdrawn for non-qualified expenses later in this article.

529 plans are established and managed by the individual states, not by the federal government. This is relevant because each state must decide how they incorporate the new federal definition of qualified expenses into their own regulations. For instance, even though the President signed the TCJA into law in December of 2017, it was mid-June of this year before the North Carolina General Assembly passed the budget act, which incorporated the federal tax changes for 529 plans into state law. Please be sure that your state has dealt with this issue.

While this article focuses on the new K-12 component for 529 plans, note that a less-publicized change in 2017’s TCJA allows 529 plan funds to be rolled over to ABLE accounts. Curious readers should know that ABLE accounts are tax-favored accounts for eligible people with disabilities (who became disabled before age 26) to use for qualified disability expenses.

As previously mentioned, 529 plans can offer significant tax advantages. Earnings in 529 accounts grow tax free and withdrawals for qualified expenses are tax free. Some states allow a deduction for state taxes for contributions made to certain 529 plans (North Carolina no longer allows a deduction). Using a special election, taxpayers can accelerate five years’ worth of contributions at one time without adverse gift tax consequences. However, please remember that if you withdraw 529 plan funds for non-qualified expenses, or exceed the $10,000 annual K-12 limit, the earnings portion of your distribution will be subject to income taxes and most likely a 10% federal tax penalty.

Planning should never be done in a silo, and this article is not an all-encompassing education planning discussion. While wealth can be transferred to children via 529 plans, strategies such as direct payment of education expenses may be a better option for some clients, for instance.

In summary, recent tax law changes should prompt many parents and grandparents to review their current wealth transfer plans. We recognize that strategies appropriate for one client may not be appropriate for others. Please call or come by to discuss planning for you and your family. As always, thank you for choosing Bragg Financial Advisors.

This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.