One small provision in the final tax reform bill could impact the way people save for the education expenses of their children and grandchildren using 529 Plans.
The new law allows greater amounts of tax-free savings than what’s permitted in a Coverdell Savings account—and the funds can be used for the same expenses. This creates an opportunity to shelter additional investment portfolio income from taxes by expanding the type of expenses that are eligible for reimbursement using 529 account funds.
For the majority of people, the new tax law also allows for greater flexibility to use the assets set aside in 529 plans. This includes K–12 expenses as well as private and religious schools, which means account owners can afford to contribute higher levels of assets to 529 plans without fear that they’ll someday be subject to tax and penalty for withdrawals that aren’t being used for education.
The law also encourages families to save additional assets in 529 plans to try and lock in some of the income tax savings and use the assets for K–12 expenses.
State & Local Tax
Under the new law, owners of 529 plans are able to withdraw up to $10,000 per year to cover K–12 expenses. Any additional money after that would still be available to use for future college expenses.
For residents of states that offer an income tax deduction for contributions to a 529 plan (Oregon, Idaho, Montana, Arizona, New Mexico, Kansas, and many others), up to $10,000 per year of private K–12 school expenses are potentially tax deductible by:
- Deducting annual contributions to a 529 plan
- Withdrawing those funds to cover education expenses
Even people that live in states that don’t allow for a state income tax deduction may still realize tax savings by investing additional assets in 529 plans and avoiding income tax on all the earnings of those accounts.
Capital Gains Tax
Annual withdrawals of $10,000 could potentially save annual capital gain taxes of 23.8% or $2,380 each year, compared to saving the funds in a traditional investment portfolio.
Financial Aid Implications
One thing to keep an eye on is how private schools change their financial aid evaluation process going forward in light of the expected increase in 529 assets.
It’s possible that private schools will look to require people to spend down some of their 529 accounts before receiving scholarships or other financial aid now that those accounts are available to be used for those expenses. That could result in parents who had previously earmarked 529 accounts for college expenses to be forced to liquidate those accounts earlier than planned.
We’re Here to Help
If you’d like to discuss your particular situation and explore if contributing to a 529 plan makes sense for your family, contact your Moss Adams professional. You can also visit our dedicated tax reform page for more information, including an overview for individual taxpayers.