Important Improvements to College Savings Accounts

College Savings

The recent Tax Cuts and Jobs Act adds exciting new options for owners and beneficiaries of 529 College Savings Accounts.  These accounts may now be used to pay for K-12 private education expenses in addition to qualified college expenses. Additionally, 529 account balances may now be transferred to 529ABLE accounts, designed for disabled beneficiaries to use without impacting government funded benefits such as Medicaid, through a tax-free rollover.

Under the new rules, 529 accounts may be used for private elementary and secondary education.  Up to $10,000 per year is now permitted to be withdrawn from a 529 account tax-free to pay for qualified education expenses of sending a student to private school. Qualified education expenses include tuition, books, and associated educational expenses. While religious schools are included in the definition of private school, homeschooling expenses are not included under the current law.

For parents and relatives of a child who is disabled or blind, the recent changes also allow a tax-free conversion from a traditional 529 account to a 529ABLE account of up to $15,000 per year. The benefit of this type of conversion is the 529ABLE account allows beneficiaries to use the funds towards education and job training programs without putting any government sponsored benefits, such as Medicaid and Supplemental Security Income (SSI) at risk due to income restrictions. Those considering such a conversion will now have the ability to transfer only necessary funds each year, as any funds remaining in a 529ABLE account at the beneficiary’s death typically go directly to the state government to help repay Medicaid expenses.

Both 529 and 529ABLE accounts are funded with after-tax money, which is invested and grows tax deferred until the money is withdrawn. If the funds in the account are withdrawn for a qualified education expense, withdrawals are tax-free. This creates a valuable long-term benefit for those saving for intermediate and long-term goals. Because of the compounding value of tax-deferral, the earlier these accounts are funded relative to the anticipated use date, the higher the value of the tax benefit. For this reason, parents and relatives who plan to fund a 529 account for private elementary or secondary education may want to give special consideration to strategies such as “superfunding” which allows 529 owners to contribute up to $75,000 per person per beneficiary to a 529 account ($150,000 per married couple per beneficiary) once every five years.

Lastly, for those residing in states with state income tax deductions for 529 contributions, special consideration should be given to making 529 contributions, which complement the reduced State and Local Tax deduction cap of $10,000 per year by reducing taxable state income. Residents of Florida, which has no state income tax, will not benefit from a state income tax deduction for 529 contributions. We would be happy to advise on 529 funding strategies for residents of all states.

Those considering funding or modifying their current 529 Plan should speak with their Wealth Advisor and Tax Advisor to review their personal situation, including a comprehensive discussion of their goals and how the new tax laws may impact these goals.

The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that a college-funding goal will be met. In order to be federally tax-free, earnings must be used to pay for qualified education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10-percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses.