When Congress passed and the President signed the Federal Tax Cuts and Jobs Act on December 22, 2017 they did more to help taxpayers than reduce tax rates and simplify filing for millions. They also made it possible to invest money tax free for virtually all education expenses, from kindergarten through college.
Provisions in the Act allow 529 Plan account owners to:
- Withdraw assets to pay for K-12 tuition up to $10,000 per year per beneficiary
- Roll over 529 Plan assets into ABLE Plan accounts, subject to the annual contribution limit
No penalties or taxes will apply at the Federal level to qualified withdrawals or rollovers from 529 accounts for 2018 and later years. What’s unclear at this point is whether such withdrawals may have state tax consequences.
Why this is good news for Gen X
While some of us already have children in college, many more still have children and grandchildren in K-12 schools. This new provision gives us more flexibility. Some of us have been funneling money into 529 plans since the late 1990s and early 2000s without any real clear sense as to how the money would be used. We just wanted to take advantage of the tax-free benefits of 529s while saving for future education expenses.
Fast forward a couple decades and the picture is much clearer now. For instance, I have one daughter in college who’s already drawing from her 529 account. My second daughter will graduate next year and stands a good chance of landing an athletic scholarship.
The new tax law gives us more options if any of the 529 plan money goes unused by either of my daughters. When they have children, I can fund 529 accounts for my grandchildren and let the families decide how to best use the money.
Options available to 529 account owners:
- Pay for higher education expenses as originally intended
- Transfer balance(s) to family members who will use it for higher ed
- Pay for K-12 tuition expenses (new)
- Roll over to ABLE accounts to help pay for disability-related expenses on behalf of designated beneficiaries (new)
What is a 529 account?
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future college costs. Officially known as “qualified tuition plans,” 529 plans are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code. If you use 529 account withdrawals for qualified higher education expenses, earnings in the 529 account are not subject to federal income tax and, in most cases, state income tax. However, if 529 account withdrawals are not used for qualified higher education expenses, they will be subject to state and federal income taxes and an additional 10% federal tax penalty on earnings.
Many states offer tax benefits for contributions to a 529 plan. These benefits may include deducting contributions from state income tax or matching grants. But college savers may only be eligible for these benefits if you invest in a 529 plan sponsored by your state of residence.
What is an ABLE plan?
ABLE Accounts are tax-advantaged savings accounts for individuals with disabilities and their families. They were created as a result of the passage of the Stephen Beck Jr., Achieving a Better Life Experience (ABLE) Act of 2014. The beneficiary of the account is the account owner, and income earned by the account(s) is not be taxed. Contributions to the account, which can be made by any person (the account beneficiary, family and friends), must be made using post-taxed dollars and will not be tax deductible for purposes of federal taxes. However, some states may allow for state income tax deductions for contribution made to an ABLE account.
Paying less in taxes is one of the simplest ways to stretch your dollars further. 529 college savings plans have always been a smart choice for parents and grandparents looking for tax-free ways to save for higher education. Now that the Federal Tax Cuts and Jobs Act expands our options to allow paying for K-12 tuition or roll over to ABLE accounts, could be a smarter choice than ever.
Important: This post is intended to be educational only and should not be relied upon as investment or tax advice. Everyone’s tax situation is unique and you should consult an expert tax preparer if you are unsure how the items above might affect to you.