Now that the Tax Cuts and Jobs Act has been signed into law it’s time to focus on the provisions that escaped the headlines so far. One such stipulation involves the permitted use of 529 Savings Plan funds for K-12 expenses.
Previously, 529 accounts were only allowed a tax-free distribution if used to pay for qualified higher education expenses at post-secondary schools (colleges and grad schools).
The new law states that families can distribute up to $10,000 per student, per year, on qualifying K-12 school expenses tax free.
This will benefit families with children in private schools all over the country. According to the National Center for Educational Statistics, the average cost of private school tuition for the 2011-2012 school year was $10,740 with middle and high school costing more than elementary school.
Prior to the tax law change only Coverdell Education Savings Accounts (ESA) could be used to pay for qualifying K-12 expenses tax free but contributions were limited to just $2,000 per year per beneficiary. Parents with existing Coverdell accounts can roll them over into a 529 account with no tax consequence now that 529s can be used for the same expenses.
For those that live in a state that provides a state income tax deduction for contributions made to its 529 plan, this could be an opportune time to make new contributions (unfortunately, New Jersey doesn’t offer a tax benefit). Parents with 529s already set up for their children with the goal of funding college may want to think about setting up a new 529 for K-12 expenses. The investment policy of the 529 to be used for elementary and high school tuition should be different than accounts earmarked for college.
The investment time horizon is shorter for K-12 and the aged-based portfolios often offered by 529 plans are calibrated for the years in which your child will be attending college. Investment options offered by 529s range from the very conservative (interest-bearing choices, short-term bonds) to aggressive (100% stocks) giving the account owner the flexibility to customize the allocation decision. Assets inside a 529 are not subject to ordinary or capital gains taxes and essentially grow tax-free when ultimately used to pay for qualified education expenses.
Finally, the annual gift exclusion amount for 2018 has been raised to $15,000 per year per person. One unique feature, only offered by 529 plans, is the ability to use up to five years-worth of the annual exclusion amount all at once. For example, a parent could contribute $75,000 in one year ($15,000 x 5 years) to a 529 plan for the benefit of her child ($150,000 if married and each parent contributes equally) and remain under the annual exclusion amount. This is an attractive technique for those willing to gift larger sums now rather than stretching them out over time. Remember, assets in a 529 plan are not considered part of your estate.
If you are interested in learning more, contact one of our advisors today.