529 Plans

The Tax Act of 2017 brought about a significant change as to the popular 529 college savings plans. That change is that they are now no longer restricted to colleges, or that is, to post-secondary education. First a brief explanation as to 529 plans. These were created a number of years ago, are sponsored by each state, and provide an opportunity to contribute money (whether it be one time, annually or frequently) to a state sponsored fund for the purpose of funding college education for anyone (typically done for a child or grandchild). These contributions are not deductible at the federal level, and depending on the state of residency, may get you a state deduction (by way of example, New Jersey offers no such deduction). 

The advantage of these plans is that the funds can build up over years, hopefully increasing in value – and that increase in value, as long as the funds are used for post-secondary education, are not taxed when earned or withdrawn. Further, there is no limit to the amount that can be withdrawn each year for post-secondary education tuition and certain other expenses. Some might argue that this no limit is not necessarily a good idea, because maybe it encourages colleges to keep on charging more and more. That’s a societal issue, and other than commenting here, not the purpose of this article.

The 2017 Tax Act has changed these rules in one very important aspect – monies from a 529 plan can be withdrawn for any level of education – high school, elementary school, private school, including for religious school. As to such non-post-secondary education purposes, there is however a $10,000 per year limitation (obviously, the promulgators of this change have no comprehension as to what private education costs nowadays).

Let me suggest that while in many ways this sounds appealing, this change is not necessarily one of which you might want to take advantage. The problem is with how soon you avail yourself of this option – in other words, high school would clearly be using the money before college (unless you had someone like a “Young Sheldon” in your house), and elementary school before high school. The sooner you access these funds, the less time they have had to build up tax-free in the 529 account. Using them too soon, you might find yourself exhausting the account before its had a chance to appreciate much – and depending on the market, maybe even when it had a loss. Thus, accomplishing little, if anything, as to the use of the 529 plan.

Two strategic move comments – and this applies only to those states where, as a resident, you would get a tax deduction for contributing to a 529 plan. Depending on that state’s rules, you might find this change to be very attractive in the sense that you can make a contribution to a 529 plan, get an immediate state tax deduction of some level, and then sort of almost immediately thereafter, withdraw the money for the education of a favored child or grandchild. Thus, you’ve created a tax deduction at the state level that maybe saved you some hundreds of dollars, and accomplished a quick turnover of your money. Whether or not this can be done is very much state specific. Also, let's say you (and your children) live in a state which provides for a 529 deduction, but the 529 is being funded by a grandparent. To secure the tax benefits, consider having your parent (the grandparent) gift you the money - so that you in turn make the 529 contributions and secure the deduction, Once again, none of this applies to New Jersey.

~Kal Barson