New Tax Act Makes 529 Plans More Useful for Clients

May 16, 2018 / By Lynn O’Shaughnessy
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The Tax Cuts and Jobs Act now allows 529 savings to cover elementary and high school education as well as college. Plus these accounts offer a way to reduce state taxes under the new law.

The passage of the Tax Cuts and Jobs Act (TCJA) created good news for parents who are saving for college.

The new law allows families to expand the use of funds in 529 college savings accounts beyond college costs. Parents and other account owners can now use the 529 plan proceeds to pay for tuition for private elementary and high school tuition.

Why 529 plans could become more popular

These expanded 529 accounts could become especially popular in blue states since the TCJA imposes limits on state and local tax deductions. Here’s why:

With the expanded approved use of 529 plans, families sending their children to private schools beginning in kindergarten can divert their tuition payments through a 529 plan to reduce their state taxes.

In some states, parents can deposit money inside a 529 account for just a day and still pocket a state tax break. Before parents try this, they should check with their state plan to make sure it hasn’t imposed a waiting period for contributions to qualify for state tax deductions.

Roughly three dozen states provide their residents with a state income tax deduction or credit when they contribute to their in-state 529 plans. The tax benefits range from $500 to the total amount of the yearly contributions.

The residents of six states can be eligible for a state tax deduction even if they invest in a 529 account outside their states. Here are those states:

  • Arizona
  • Kansas
  • Minnesota
  • Missouri
  • Montana
  • Pennsylvania

Here are states that offer generous tax deductions/credits for 529 contributions:

  • Arkansas
  • Idaho
  • Indiana
  • Iowa
  • Missouri
  • Montana
  • Nebraska
  • New York
  • Oregon
  • South Carolina
  • Vermont
  • Virginia
  • West Virginia
  • Wisconsin

In contrast, the following seven states, which have state income taxes, do not offer any tax benefit for contributing to a 529:

  • California
  • Delaware
  • Hawaii
  • Kentucky
  • Maine
  • New Jersey
  • North Carolina

Expanded 529 plan coverage

The new legislation will allow account owners to use up to $10,000 a year in expenses from kindergarten through 12th grade at private and religious schools.

Parents who want to use a 529 to pay for pre-college expenses may want to create a separate account to cover these costs.

Coverdell Education Savings Accounts vs. 529 accounts

Previously, parents who wanted a tax-advantaged education account to pay for pre-college costs had to use the Coverdell Education Savings Account (ESA).

The Coverdell ESA, however, has income eligibility limits and contribution limits of just $2,000 per beneficiary per year. Parents who would like to move money from a Coverdell to a 529 plan can do a rollover without triggering taxes.

529 plans and ABLE accounts

The TCJA also permits existing 529 college accounts to be transferred into 529 ABLE accounts. ABLE accounts are tax-advantaged accounts that are designed to allow individuals to save money for loved ones who have disabilities. The assets in an account can be used for education and other expenses such as medical treatments, job training, housing, legal fees and assistive technology.

A big feature of ABLE accounts is that the initial $100,000 is not treated as the beneficiary’s personal asset. This is important because federal law generally restricts individuals’ eligibility for Medicaid, housing assistance and Supplement Security Income if they have assets that exceed $2,000.

Being able to transfer money from a 529 account to an ABLE could be especially helpful to parents who created college accounts before learning about their children’s disabilities. Previously, money transferred from a 529 to an ABLE account was considered a taxable event. The distribution was not considered a qualified withdrawal so it was subject to income tax and a 10% withdrawal penalty.

While the TCJA did not drastically alter the college planning landscape, the expanded options and utility of 529 plans is something that clients with children need to know about.

Lynn O’Shaughnessy is a nationally recognized college expert, higher education journalist, consultant, and speaker. She is also the leader of Horsesmouth’s Savvy College Planning program.

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