Using 529 Accounts For More Than Just College NowSubmitted by Castlebar Asset Management on February 5th, 2018
529 accounts have been the most common way for parents and families to save for college. Prior to 2018 these accounts could only be used for higher education expenses. The new tax law passed at the end of 2017 allow for 529 accounts to be spent on any approved educational expenses. This means that parents who send their kids to private K-12 now have a new way to approach paying for private school.
The Tax Cuts and Jobs Act (the new tax law) has expanded the use of 529 plans. You can now take up to a $10,000 distribution each year, per child to pay for elementary and secondary school expenses. This can be tuition, fees or books at public, private or religious institutions. 529's have historically been used to accumulate funds for college over many years. The benefit for your kids was their 529 accounts would grow tax deferred over that period of time. In the short term, you would benefit by getting the state tax deductions or credits each year for your contributions. With this new wrinkle in the tax law, parents who have large K-12 expenses may take advantage of some new strategies to help lower their state income tax burden.
529's will now likely have a dual role in your financial life. You will still use it as a long term account for college but also as a way to optimize your state income taxes in the short term. Here are a couple of examples to demonstrate.
Example 1: You live in Missouri and are contributing $300 per month to your child’s 529 account for college. Your child goes to a private high school that costs $12,000 per year. Missouri has an $8,000 limit on their 529 contributions for tax credits. You can contribute more, but won’t receive the state income tax deduction. In this case since you are contributing $3,600 a year for college you could contribute $4,400 to your 529 to maximize your state income deduction.
Example 2: You live in Kansas and are contributing $200 per month to your child’s 529 account for college. Your child goes to a catholic elementary school that costs $4,000 per year. The contribution limit for state tax deductibility is $6,000 in Kansas. In this case since you are contributing $2,400 a year for college you could contribute $3,600 to your 529 account to maximize your state income deduction.
There are things that you will need to take into consideration with this new contribution strategy. You will be taking some market risk even if you are using your 529 as a parking lot for the income tax deduction. There are always market fluctuations and in the event of a significant sell off you may have less than 100% of your contributions available to pay out. You can change your investment allocation for the short term, but you are only allowed to change a 529’s allocation twice per calendar year to prevent too much tinkering.
You will need to know what your state’s contribution limit is for the state income tax deduction. Each state sets its own rules on how much of your contribution is deductible off your state income. The range is from $0 to $28,000 so you will want to check what your states rules are. Currently 35 states offer a tax break of some kind. The other thing you will want to check is if your state has any rules penalizing you for a quick contribution and then distribution. The only states that have these rules in place today are Montana and Wisconsin.
This change to the 529 laws are new and states may decide to make some changes to their state income tax laws to reduce the benefits. Higher income families will see much of the benefit from these rules. Additionally, most states are hurting with their state budgets so additional tax deductions may be something they address.
Using a 529 as a parking lot for your private school expenses is something to look into if you are sending your children to private K-12 schools. Parents sending their children to public schools with fees, book expenses or other approved expenses can also benefit from this. You will only receive state tax benefit (if your state allows it) but no federal tax relief from this new law.
Disclaimer: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.