How to Make “Cents” of the Changes to 529 Plans
Are you saving for your child’s education with a 529 account?
If you are already contributing to a 529 plan, reduced deductions in the new 2018 tax law mean you may want to increase your contributions – or even create a second 529 account – to offset higher state taxes.
If you haven’t yet opened a 529 account, this year’s important changes in tax and 529 regulations have made 529 accounts an even more valuable option for parents of school-aged or college-aged children.
Here are the changes and why contributing to a 529 account is more important than ever:
K-12 Tuition is Now Covered by 529 Plans
529 plans were originally created to let you to save and invest for your child’s college education – while paying no federal tax on qualified withdrawals. The good news is that benefit has now been expanded: you’ll be able to withdraw up to $10,000 per year per student for elementary, middle, and high school tuition if your child attends or will attend a private or religious school. And, if you’ve already been saving for K-12 with a Coverdell ESA, you can also rollover that account to a 529 plan without tax consequences.
Saving by Off-Setting State Taxes
The new 2018 tax law limits deductions for your state income and property taxes to $10,000, so you might find yourself paying more state tax this year. But if you live in one of the 34 states that offers a state tax deduction for contributions to a 529 plan, you can lower your state taxes by contributing more to your 529. In most states you have to be enrolled in one of that state’s own plans to take the deduction, but several allow you to deduct contributions from any state plan. And, if you live in one of the several states whose 529 plans include state tax credits, you could also find yourself paying considerably less.
Turbo Charging the Benefits for Younger Children
529 plans allow “front-loading,” a term for making up to five years of contributions at once. This not only allows you to “catch up” for a child already in elementary or secondary school, it also allows you to maximize state tax deductions or credits. And anyone can make contributions to your child’s 529 plan. Friends and relatives can each contribute up to $15,000 per recipient, they can also “front-load” up to five years of contributions as well, maximizing their own tax savings. Additionally, if they make direct payments to services provided for beneficiaries’ tuition or medical expenses, these expenses would be tax-free, even though the costs surpass the annual gift tax exclusion.
New Benefits for Special Needs Students
The new tax law allows assets in 529 accounts to be transferred to ABLE accounts without any penalties as long as they are transferred by 2025. ABLE plans – named for the Achieving a Better Life Experience Act – are designed to provide tax-favored savings for people with disabilities without limiting their access to benefits such as Medicaid, Social Security Disability Insurance (SSDI) and Supplemental Security Income (SSI). The annual contribution cap for ABLE plans is $15,000 and an account can reach $100,000 without affecting SSI benefits. You can also make tax-free withdrawals when paying for expenses such as housing, legal fees and employment trainings.
Plans Can Be Transferred to Another Child
If you no longer need the account for the child it was created for, you can change the plan’s beneficiary to another family member, saving you the income tax on 529 earnings and 10% federal penalty you pay if you withdraw money for non-educational purposes.
The Bottom Line
Every parent – and grandparent – should consider opening one or more 529 accounts for their children’s education. There is no limit to the number of plans you can contribute to, or the number of accounts that can be opened for any child, so study up to determine which plans make the most sense for you. But remember: each state’s rules are different so – like your kids – you’ll want to do your homework.
Then, as with all smart savings plans, contribute on a regular basis over time, through market ups and downs, to benefit from dollar cost averaging and watch your interest compound – and your child’s educational opportunities grow.
For how the new tax law affects the “Kiddie Tax” for Uniform Gifts and Transfers to Minors (UGMAs and UTMAs) please click here.
At Sherman Wealth Management we’re passionate about children’s education so please give us a call if you have any questions about your state’s 529 options.
A version of this article initially appeared on Investopedia.com