Since they were first established in 1996, Section 529 college savings plans have become a popular tool used by parents to save for future college expenses. Families have established nearly 13 million such plans over the past two decades, and assets in these plans rose to $282 billion in Q3 last year.
One reason 529 plans are so popular is the tax breaks they allow. As long as funds are used to pay for qualified education expenses, earnings within the account grow tax-free. Also, many states allow full or partial deductions for 529 plan contributions.
Good Gets Even Better
Believe it or not, 529 plans just got another boost that makes them potentially even more attractive than they were before. This new benefit comes courtesy of the tax reform that was signed into law in December.
The tax reform act includes a provision that allows 529 plan funds to be used to pay for qualifying elementary and secondary school expenses, as well as college expenses. So if you want to withdraw some money from your 529 plan to help pay for private elementary or high school expenses, you can now do so without paying a penalty or taxes.
Before the tax reform legislation, any 529 plan withdrawals that were not used to pay for qualified college education expenses were subject to ordinary income tax and a 10% tax penalty on the earnings portion of the distribution. Now, up to $10,000 of 529 funds can be withdrawn each year to help cover primary and secondary private school tuition.
If you believe you might want to withdraw some 529 funds to help pay for K-12 expenses, you may want to consider opening an additional account within your 529 plan. This will make it easier to keep track of your separate K-12 and college education savings goals and choose the most appropriate investments based on your investment horizon, risk tolerance, and withdrawal schedule.
However, keep in mind that if you withdraw 529 plan funds to pay for K-12 expenses, this could impact your carefully laid college savings plans. Every dollar withdrawn from a 529 plan early is a dollar that won’t be there when your child is ready to start college. So think carefully before withdrawing 529 funds early, even if the money won’t be subject to a taxes and penalties.
A 529 Plan Refresher
Meanwhile, here’s a quick refresher on Section 529 plans if you’re not familiar with how they work:
- Money saved in a Section 529 account can be used to pay for a wide range of different kinds of education expenses. These include not only tuition, fees, books, and room and board, but also computer technology, computer equipment and related services, such as Internet access. There are specific requirements for each of these types of expenses to be considered qualified education expenses, so please speak with a financial advisor if you’re not sure if your student’s expenses meet those requirements.
- There are two main types of Section 529 plans: prepaid tuition plans and investment savings plans.
- Prepaid tuition plans lock in a specific amount of future tuition at today’s prices, giving you more certainty when it comes to future college expenses. With this type of plan, you could buy four years of college now for your newborn at today’s tuition rate, which is probably much lower than it will be 18 years from now.
- Investment savings plans, meanwhile, are more like retirement savings accounts. They enable you to invest your college savings in stocks, bonds and mutual funds to try to maximize returns. Remember, though, that there’s no guarantee your investments will be successful, so you will be putting your college savings at risk.
- Your child is not restricted to attending college in the particular state where your 529 plan is opened – or even the United States. 529 plan funds can be used to pay for educational costs at any college eligible for Title IV federal student aid, including some colleges located outside the U.S. and vocational-technical schools. Most states now offer Section 529 plans, so you can choose the best plan for you and your child without worrying about limiting your college options.
The recent changes to Section 529 plans might make them worth considering if you don’t have a plan right now. You should talk to your financial and tax advisors for detailed guidance about college saving strategies and the tax treatment of Section 529 plan contributions.
Read our free Personal Capital 2018 Tax Guide for Holistic Financial Planning to learn more about taxes and your long-term financial planning.
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