Changes to 529 Plan Rules
The Tax Cuts and Jobs Act passed over a year ago expands the benefits of 529 savings plans.
The new provision in the tax reform law will be a benefit particularly for parents of children in elementary and high school, as the new law expands the use of the plan into these education levels. Here are the basics and what has changed:
529 Education Plans
529 plans were offered to help families save for a child’s college education. The funds in your 529 account are not subject to tax while they remain in the account. When they are withdrawn, the funds are also not subject to tax if they are used for qualified education expenses. The 529 contribution is not deductible on your Federal income tax return. However, some states offer a deduction for 529 contributions, but the amounts and conditions vary by state.
Once money is withdrawn, it can be taken tax-free, as long as it is used to pay for qualified education expenses. This can include basic tuition, fees, books, room and board, and any computer equipment or software required as part of the course of study.
Changes with the New Tax Law
There have been a few changes to the 529 plan under the tax law passed in December 2017, and they mostly favor the taxpayer.
Parents can now use the 529 plan to pay for their children’s education at private elementary and high schools (including some parochial or religiously-affiliated schools but excludes homeschooling at this time). Previously, this was a benefit provided only by Coverdell Education Savings Accounts (ESA). The 529 plan is now available to parents of younger children in private schools.
529 Plan Benefits Can Be More Favorable Than the Coverdell ESA
Unlike the Coverdale ESA, there are no income limits for the 529 plan.
While the Coverdell ESA has a contribution limit of $2,000 per student, the 529 plan has no annual contribution limit. However, so as not to incur the federal gift tax, most people cap their annual contribution at $15,000. While there is no annual limit, there are lifetime limits. View your state limits here savingforcollege.com.
Under the Coverdell ESA, contributions cannot continue once the child beneficiary attains the age of 18. There is no such contribution limit with 529 plans. That means the same plan used to fund elementary and high school education can also be used for college, through continued contributions. Also, 529 plans do not require a withdrawal of plan funds by any certain age. Under the Coverdell ESA, withdrawals must be completed by age 30.
If you have a Coverdell ESA, and want to move it into a 529 plan, you can do so with no tax consequences.
Rollovers of 529 Plans into ABLE 529 Plans
In 2014, ABLE accounts were established to help Americans living with disabilities save for their children’s education. They were created so that people with disabled kids trying to accumulate funds for education wouldn’t be penalized since disability income rules set strict limits on how much money a person can have in savings, and still be eligible for disability income.
ABLE plans have the same benefits as 529 plans, including tax-free investment growth and tax-free withdrawals when funds are used to pay for qualified education expenses. But they can even be used for job training, healthcare, and other expenses.
Under the new tax law, existing 529 plans can be rolled over into ABLE 529 plans. This might be a consideration if a regular 529 plan was established before a child became disabled. As a result, families collecting disability will not lose their eligibility because of 529 education savings.
A Word of Caution
There are a few things to consider with the new rules. First, distributions taken from a 529 plan to cover qualified education expenses are limited to $10,000 per year for elementary and high school education. The main benefit of a 529 plan is a tax-free accumulation of investment income. Since funds needed for elementary and high school education happen much sooner than college, there will be less time for the plan to build up value. A plan started at birth may require withdrawals beginning as early as age five.
On the investing side, you usually don’t have complete flexibility with where and how you will invest the money. You may need to look outside your home state’s plan to find one more suitable. As with all financial decisions, be sure to discuss with your advisor before making any changes.