In recent weeks, we’ve been discussing higher education costs and the importance of saving for college to avoid relying on financing. In the past we have also examined different versions of the 529 Plan, which is one college savings strategy that offers a number of benefits. In light of the passage of the Tax Cut and Jobs Act, there are a few significant updates to 529 Plans that are worthy to note.
529 Plans: an overview
529 Plans, named after Section 529 of the IRS tax code, is essentially an account designated for the college expenses of the account’s beneficiary. There are two basic types of 529 Plans: 529 Savings Plans and 529 Prepaid Plans. Some states offer both types, but an education institution may only offer prepaid tuition 529 plans.
Prepaid 529 plans are essentially pre-payments of tuition credits for an in-state public college. This type of plan allows parents to lock in tuition at today’s rates, which can be useful as college costs continue to increase every year. There’s also a privately-run program called the Private College 529 Plan, which allows you to purchase tuition credits from just under 300 participating colleges.
A 529 Savings Plan is an investment account, unlike a prepaid plan that serves as a purchase in advance. Similar to an IRA or 401(K), contributions into the account are placed into investments such as mutual funds.
529 Savings Plans have several benefits:
- Accounts are generally exempt from federal, state, and local taxes.
- Lifetime contribution limits are high (between $235,000 – $500,000).
- Earnings grow tax-free, and withdrawals are tax-free when used for qualified expenses.
- 529 plan deposits of up to $14,000 per person ($28,000 for jointly filing married couples) fall under the annual gift tax exclusion. Keep in mind the gift tax will apply to contributions over these amounts.
- Virtually anyone- relatives and non-relatives- can contribute to a child’s 529 Plan.
- 529 plans are often competitive, with different states offering various features; you may contribute to 529 plans in states other than your primary residence.
- The named beneficiary can be changed if necessary.
While 529 Plans have their share of benefits, keep in mind that the Savings Plans are not entirely penalty-free. Withdrawals for qualified expenses such as tuition and fees, books and supplies, and room and board (for students attending at least half time or more) are not subject to penalty, but non-qualified withdrawals are subject to a 10% penalty on gains earned in the account, as well as income tax on those gains.
529 Plans and the Tax Cut and Jobs Act
Uncertainty about education-related deductions, credits and benefits surrounded the tax bill due to the fact that there were drafted versions of the bill that sought to do away with the student loan interest deduction, Coverdell Education Savings Accounts, and the Lifetime Learning Credit. The final bill maintained these items while also expanding the use of 529 Plans.
The new law allows qualified education expenses to apply to K-12 rather than college only. Starting this year, custodians of a 529 savings plan may make annual withdrawals of up to $10,000 per student to pay for tuition expenses at an elementary or secondary public, private, or religious school; these withdrawals are not taxed federally. There are some states that will need to make legislation to update K-12 expenses as a qualified education expense, but there are many states that automatically reflect updated federal law.
In addition to expanding 529 plans to pay for elementary and secondary education costs, 529 account custodians may also transfer 529 funds to an ABLE plan, an account designated for disability-related expenses.
Scholarships and financial aid have been longstanding, popular tools used to pay for college, but 529 Plans can be an incredibly powerful way to give your family’s college savings plan a healthy foundation. There are a great number of 529 plans available, which can be both advantageous and daunting. Meeting with a trusted financial advisor can help your family determine the plan that offers the best features and benefits tailored to your unique needs.