Benefits Of 529 Education Accounts Expanded Under 2017 Tax Reform

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Tax reform expanded the use of 529 education savings accounts to the point that many states are worried it will break their budgets. The accounts now are an excellent way to help pay for a child’s or grandchild’s education at any level

You’re probably familiar with 529 college savings plans. They were created in the 1990s as sort of like Roth IRAs for college savings. Every state sponsors one or more 529 savings plans.

In a 529 savings plan, you contribute money to an account and name a beneficiary, usually one of your children or grandchildren. The money in the account is invested, and the income and gains compound tax free. Some plans let you choose how the account is invested from among mutual funds selected by the plan sponsor. In other plans, the sponsor decides how the money is invested or allows you to choose from several diversified portfolios it manages.

When money is distributed from the account to pay for qualified educational expenses, the distribution of the principal and earnings is tax free. If a distribution isn’t used to pay for qualified education expenses, the earnings are taxable and there likely will be a 10% federal tax penalty.

There also are estate and gift tax benefits. Contributions to an account qualify for the annual gift tax exclusion. So you can deposit up to $15,000 per account beneficiary in 2018 without worrying about

the effect on your lifetime estate and gift tax exclusion. In addition, you can bundle up to five years of

annual gifts in one year, allowing you to make up to $75,000 of tax-free contributions per beneficiary

in one year.

You can change the account beneficiary. You even can take the contributions back for any reason without tax consequences, though there might be a penalty of up to 10%.

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The Tax Cuts and Jobs Act of 2017 increased the benefits of 529 savings plans. Previously, the plans could be used to pay only for post-secondary school expenses. Under the new law, the plans also can be used to pay for up to $10,000 of tuition annually for kindergarten through grade 12. The $10,000 is per student, not per account. Therefore, a student who is a beneficiary of multiple accounts can have only a total of $10,000 distributed tax free each year to pay for K-12 expenses. Excess distributions are included in gross income.

For grades K-12, only tuition qualifies for a tax-free distribution. When the distribution is used to pay expenses other than tuition, it’s not qualified and therefore not tax free. (The definition of qualified expenses is broader when the money is used for secondary education.)

The school can be public, private, or religious.

Though contributions to 529 plans aren’t deductible on your federal income tax return, more than 30 states allow full or partial deductions for contributions to 529 plans; some allow other benefits, such as tax credits, instead of deductions. Some states allow their residents to take deductions or credits only for contributions to a plan sponsored by the state, while others allow the tax breaks for contributions to any 529 plan.

Traditionally a 529 savings plan is used to accumulate money for education expenses years in the future. You contribute money to an account when the beneficiary is young, and the income and gains compound tax free until the beneficiary is ready to enroll in college.

The new law creates a new strategy for anyone who’s helping to pay the private school tuition of a child or grandchild and whose allows a tax break for 529 account contributions. In that case, consider opening an account with the youngster as beneficiary. Contribute to the account an amount at least equal to the maximum state tax benefit. When tuition is due, distribute an amount equal to the tuition. You receive a state tax break for paying the tuition through the 529 account, which has added value now that federal deductions for state and local taxes paid are limited to $10,000. Any income earned by the account is free of federal and state income taxes.

Read your state law closely. Some states, such as New York, limit the tax breaks to 529 accounts that pay for college-related expenses. States are debating whether to change their laws to match the new federal law. Also, many states are worried the federal law change will increase use of the plans and cost them a lot of tax revenue. They’re considering reducing or eliminating the state tax benefits. So, if this is strategy is attractive to you, take advantage of the benefits while you can.

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https://www.forbes.com/sites/bobcarlson/2018/06/16/benefits-of-529-education-accounts-expanded-under-2017-tax-reform/