If your child attends a K-12 private school, there is no federal tax deduction or credit you qualify for that will help pay for tuition — not even school uniforms. For years, private school parents have been paying local taxes to support schools while still paying tuition with no tax breaks. President Trump recently signed the 2017 Tax Cut and Jobs Act. The bill brought major changes to corporate and personal tax rates and deductions. It also brought a major change to 529 saving plans.
What is a 529 saving plan?
A 529 plan is an investment account designed to encourage families to save for future college expenses. Parents can invest after tax dollars on behalf of a child for the purpose of education. Money contributed to the 529 is not tax deductible, but any growth in the investment is tax free. 529 plans have no income limits. Money invested in 529s must be spent on "qualified education expenses". If you remove it for other purposes, you will pay a penalty.
What are the changes to 529s?
The new tax bill, allows parents to withdraw funds from the account not only for college; but also to pay for K-12 private education. Families will be able to withdraw up to $10,000 per year tax free for elementary and high school fees such as tuition and books.
What happens if I have money left in my 529 after high school and/or college?
You can withdraw the money for other purposes and pay a penalty. You can transfer the money to another beneficiary either yourself, another child, or relative.
Here are a few other things to remember:
- Don’t forget to start early. It takes time to reap the benefit of compound interest. If you start with an initial $5,000 investment and invest $100 per month from birth to 5 years old, you will have saved $14,796.23 to start kindergarten (assuming an 8% interest). This won’t get you too far, but it is a start. You can check out an investment calculator here.
- Don’t forget the tax benefit is only on the growth. Initial investment in the 529s are after tax. Again, you must invest over a long period of time to get the maximum tax benefit.
- Don’t forget grandparents. Funding education for grandchildren is often an important priority for grandparents. Grandparents can reduce their estate tax exposure through making 529 plan contributions, which are considered “gifts” for tax purposes. Additionally, if they are approaching age 70 ½ (or already there), the IRS requires them to take distributions or withdrawals from IRAs, 401(k)s or other employer-sponsored retirement plan. If they have enough saved for retirement, leftover funds can be reinvested into a non-IRA account such as a 529 college savings account.
- Don’t forget gift tax limits. If you make a taxable gift (one in excess of the annual exclusion), you must file Form 709: U.S. Gift (and Generation-Skipping Transfer) Tax Return. The return is required even if you don't actually owe any gift tax because of the $5.6 million lifetime exemption. The 2018 limits is $15,000 per individual and $30,000 per married couple.
- Don’t forget to check your state laws regarding 529s. 529 plans are administered by states. And not every state law automatically complies with the new rules. That means families could be hit with an unexpected state tax bill.
- Don’t forget to save for college. The average cost of tuition and fees for the 2017–2018 school year was $34,740 at private colleges, $9,970 for state residents at public colleges, and $25,620 for out-of-state residents attending public universities. Research shows that the average parent is not saving nearly enough to cover the cost.
The information provided in this blog is general. Please consult with a qualified financial advisor before making 529 investment decisions. There may be financial caveats that apply to your specific situation not mentioned here.