No matter what your income level, paying the high costs of education can be a major challenge. For parents who opt to send their kids to private elementary and secondary school, paying tuition in those early years can make saving for college even more difficult. If you’re feeling the pinch and looking for a great way to fund every stage of your children’s education, the new tax laws just handed over a valuable new bonus.
In the past, funds from 529 plans could only be used to cover qualified college expenses. Under the new tax law, distributions can now be used tax-free for private elementary and secondary school expenses of up to $10,000 per student each year. Compared to educational IRAs that are currently capped at $2,000 in contributions per year and are unavailable to high-income earners, this new tax-free benefit is huge for parents of the more than 5.2 million students now enrolled in private elementary and secondary schools in the US.
Of course, while having the freedom to use the assets of a 529 plan for earlier education is great, it’s important to play by the rules to be sure you make every dollar count.
Here are 6 rules of thumb to help you make the most of the more flexible guidelines:
- Be smart about when and how you contribute. If you have the assets to make a lump-sum contribution, keep in mind that contributions of up to $15,000 per year can be made to a 529 without triggering federal gift taxes. Gifts of more than $15,000 are fine, but they must be averaged out over 5 years. This means that as much as $75,000 can be gifted to a particular 529-plan beneficiary in a single year to grow and use tax-free in the future—just be sure to stay within the $75,000 limit for each 5-year period.
- Ask Grandma to put a bow on that generous gift. It’s wonderful when grandparents offer to contribute to your child’s 529, but while there are exceptions, in most cases it is best to name the student’s parent as the primary account holder. When a 529 plan is owned by the parent, it is treated as a parental asset for financial aid purposes, and just 5.64% of the value of the 529 plan is counted towards the Expected Family Contribution (EFC). Importantly, these funds are not counted as “income” for FAFSA purposes. However, if a grandparent owns the 529, distributions are counted as income for the student, which could have a negative impact on the student’s financial aid rewards. The best solution: Ask grandparents to make a gift to a 529 plan for the student held in the parent’s name or the student’s name instead.
- Beware of naming the student as the account holder. If the student is a dependent, 529 assets held by the student are treated as a parental asset for the purposes of financial aid, but that doesn’t necessarily make it the best choice. When the plan is in a parent’s name, the beneficiary can be changed at any time, providing the flexibility to pass on any unused funds to another child, grandchild, or spouse. When the account is in the child’s name, unused funds are owned by the child, which limits your choices. In addition, naming a child as the account holder instead of the beneficiary gives him or her 100% access to the funds at age 18. Even the most responsible teens aren’t known for making the wisest choices, so it’s best to keep those assets in more capable hands to be sure nothing is withdrawn for the wrong reasons and used for anything but education.
- When in Georgia, save in Georgia! Every state is different, but Georgia gives a $4,000 tax deduction per child/per year when you use the Georgia plan. (Note that most states offer a 529 plan, and you can invest in any of these plans, regardless of where you or the student resides.) This means that in addition to the standard benefits of the plan, you can save about $240 per child in taxes on each $4,000 contribution. You can always add the additional contributions or rollover balances to a 529 plan in another state (we typically recommend the Utah plan for larger balances).
- Pick your plan with care. Why do we recommend the Utah plan? The answer is complicated—and dependent on the financial picture of the individual investor. Every plan has its pros and cons, and every situation is different, so it’s best to work with your advisor to determine the plan that best fits your needs. Always pay attention to costs, evaluate investments and financial aid considerations, and be sure the risk of your investment options is aligned with the time horizon. Keep in mind that funds earmarked for elementary or secondary school will likely have a relatively short time horizon. The last thing you want is to see your balance drop significantly just as that tuition bill comes rolling in.
- Don’t rob Peter to pay Paul! If you’re struggling to cover the high costs of your child’s private elementary or high school, it can be tempting to raid the piggy bank now to ease today’s burden. But it’s vital that you don’t risk underfunding the even higher costs of college down the road. Make college the top priority in your savings plan, and then leverage your 529 to support the earlier years when you can.
Tuition bills can put a dent in your budget. The good news is with the flexibility to use tax-free 529 plans to fund education even before college, you can also put a nice dent in your tax bill next year—and for years to come. Again, every situation is different, so work with your advisor to make the choices that are best for you.
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