The New Tax Bill and College Savings
Thomas M. Geier, CPA, CFP®, PFS
The recently passed Tax Cuts and Jobs Act made significant changes to both individual and business tax situations. One area that many people do not know about is the expansion of College Savings Plans or 529 plans.
Designed to promote saving for future college costs, a 529 plan is a tax-advantaged savings plan authorized by Section 529 of the Internal Revenue Code. Sponsored by every state and the District of Columbia, there are two types of 529 plans: Prepaid Tuition Plans and College Savings Plans.
In simple terms, a Prepaid Tuition Plan allows you to effectively lock-in tuition costs to avoid tuition inflation, whereas a College Savings Plan is a tax-advantaged investment account. With a 529 savings account, you can set aside after-tax contributions that grow tax-free—the proceeds can be used for qualified educational expenses, such as tuition, room and board, and books. Many states offer tax breaks and credits to residents, so it’s worth examining the 529 plan offered in your state. But it’s important to know that many states no longer offer a Prepaid Tuition Plan, so talk to a financial advisor well-versed in your state’s offerings.
Consider 529s as Education Accounts
The Tax Cuts and Jobs Act changed the 529 plan in a few ways. Parents might want to consider 529s as education savings accounts rather than simply college savings accounts. Under the new rules, money from a 529 can be used tax-free on qualifying expenses for K-12 private and religious schools.
What Are Qualified Expenses?
Before the Tax Cuts and Jobs Act, qualified expenses were those incurred at a post-secondary school and included tuition, fees, books, supplies, and equipment. While these qualified expenses still exist, the list of qualified expenses was increased to include expenses from K-12 as well as religious schools. But there is a catch to the new K-12 rules: those expenses can cover no more than $10,000 during a tax year beginning after 2017.
The State Tax Deduction Challenge
Right now, earnings on qualified withdrawals for K-12 expenses are tax-free at the federal level for everyone. However, the withdrawals may or may not be state tax-free, and any tax benefits taken on deposits may be subject to recapture. The challenge is that every state has its unique tax laws on 529 plans and not every state has amended their laws to mirror the federal law when it comes to K-12 expenses. So, parents need to exercise caution if they are considering withdrawing money to pay for tuition at a K-12 school because they may incur state tax penalties. Right now, according to the College Savings Foundation, approximately 20 states treat K-12 expenses the same as federal law, as their legislation mirrors federal definitions. But it’s important that parents review their chosen program to determine whether or not there may be state tax penalties.
The 529 ABLE Account
529 ABLE is an acronym for “Achieve a Better Life Experience.” These accounts were established in 2014 to allow families with disabled children to save in a tax-deferred account. One of the benefits of these accounts is that, as long as the account does not exceed $100,000, they do not count as assets when determining state and federal aid eligibility.
The new Tax Cuts and Jobs Act allows parents to roll over the annual gift limit amount (up to $15,000 for 2018) from an existing 529 account into a 529 ABLE account for the same beneficiary. This is great news for families because regular 529 plans typically count against state and federal benefits.
Revisit Your Education Savings Strategies
The rising costs of education and the potential burden of student loans have made saving for education more important than ever. And while the laws are constantly changing, remember this: It’s never too early to begin your child’s education funding plan.
However, as with other types of financial planning, bear in mind that your child’s education funding plan requires a disciplined approach that emphasizes consistency with your overall goals and objectives.
Planning is Key
Here is where planning comes in: a financial advisor can help you establish a goal and determine how much you need to (and can) save for your child’s education. More than simple saving, this means creating a plan and choosing the right investment vehicles so that you can increase growth potential and steadily accumulate more for education.
Your biggest advantage for saving for education is time. The sooner you start saving, the more time you have to grow your education fund through long-term compounding.
At Geier Asset Management, contact us, and we would be happy to discuss your college funding options and the best alternatives for you and your family.
Sources: eMoney ABM.
© Geier Asset Management, Inc. Aug 2018. Thomas M. Geier is a Vice President of Geier Asset Management, Inc., a Registered Investment Advisor. The above blog reflects the opinions of Mr. Geier and not necessarily the firm. Any advice given is general and investors must consider their circumstances. Past performance is no indicator of future performance.