Included in the recent Tax Cut & Jobs Act (TCJA) 500 plus pages were changes to numerous tax provisions. Among those changes are how you can use funds set aside in section 529 College Savings Plans.
Over the past two decades, section 529 College Savings Plans have become a very popular way to save for future college costs. Just about every state offers one. You can invest in any state’s plan (even if you are not a resident of the state) and use the funds for any qualified institution, not just those within your state. While contributions to 529 Plans are made with after-tax dollars, the funds grow tax-free. Distributions are also tax-free as long as the dollars are used to pay qualified educational expenses.
Major Rule Change TO 529 Plans
Prior to January 1 2018, tax-free distributions from 529 Plans were only allowed to pay for qualified higher education expenses (college, grad school, etc.). Paying for expenses of children in Kindergarten through 12th grade (K-12) were only permitted from a Coverdell Educational Savings Account. However, this was never a popular strategy because contributions to Coverdell Accounts are significantly more restricted than contributions to 529 Plans.
The TCJA has now changed that rule. As of January 1, 2018, up to $10,000 each year, per child, can be paid from 529 Plans for qualified educational expenses of a child in grades K-12.
According to the TCJA, qualified educational expenses for K-12 are:
- Expenses for tuition at an elementary or secondary public, private, or religious school.
- Expenses for curriculum and curricular activities including:
- Instructional materials
- Online educational materials
- Tuition for tutoring or educational classes outside the home, provided the tutor or instructor is not closely related to the child
- Educational therapies for students with disabilities in connection with a homeschool
How much can I contribute to 529 Plans?
The annual gift tax exclusion amount you may give to a person without creating a taxable gift has increased from $14,000 to $15,000 in 2018. So a married couple can now make annual exclusion gifts of up to $30,000 per year, per recipient.
But there’s a special rule for 529 plans. If a married couple wanted to aggressively fund a 529 Plan, they may make a contribution of up to $150,000 ($75,000 if single) per beneficiary in a year. For gift tax purposes, the contribution would be considered a gift made for the current year and for the following four calendar years. In essence, this allows pre-funding the 529 Plan, allowing your 529 Plan the opportunity to accumulate earnings and appreciation faster. Note, that taking advantage of this accelerated gifting provision means that annual exclusion gifts cannot be made for the next four years.
As always, please consult with your individual tax advisor as everyone’s situation may be different.
How much can a 529 account have in it?
There is no maximum amount of money you can have in a 529 Plan. However, contributions are no longer permitted once all account balances reach $400,000 for the same recipient in Illinois 529 plans. Each state has a slightly different limit on the maximum amount you can contribute.
State tax benefits
Over 30 states, including Illinois, offer a state tax credit or deduction for contributions made to a 529 Plan. Contributions to an Illinois sponsored 529 Plan of up to $10,000 per year by an individual, and up to $20,000 per year by a married couple filing jointly, are deductible in computing Illinois taxable income.
Qualified distributions from a 529 Plan for higher education expenses are also exempt from state income taxes. Please note, however, that it is not clear at this time how states will treat such distributions for K-12 expenses.
Allowing 529 Plan funds to be used for qualified K-12 expenses opens up some potentially interesting planning opportunities. Please reach out to us at Strategic Wealth Partners to see how you may be personally affected by the new law.