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529 Plans, Now A Savings Vehicle For College AND Private School

529 Plans, Now a Savings Vehicle for College AND Private School

Educational savings plans have been modified as a result of the new tax laws. One good change is that 529 plans are now a savings vehicle for college and private school. Let’s start with a brief 529 plan refresher. Historically, families have funded 529 plans in order to gain tax free growth with the requirement that distributions were used to pay for higher education expenses. The money inside the 529 plan would grow tax free and then distributions would also be tax free avoiding any capital gains tax on the growth of the investments. In addition, some states including New York and Pennsylvania (New Jersey excluded), would offer a state income tax deduction towards a portion of the contributions made into the 529 plan. The state income tax deduction on contributions is nice, but the main benefit to funding 529 plans has always been the tax free growth of the investments. One dollar contributed at the birth of the beneficiary could easily be worth over $2 by the time they reach college age. That 100% increase and avoidance of capital gains could translate into substantial tax savings.

There are no annual contribution limits for 529 plans, but there are maximum aggregate limits which vary by state and tend to be quite high.  However, contributions to 529 plans are considered a gift, so some families will contribute up to the annual gift exclusion amount up to $15,000 per spouse, per beneficiary in 2018. There is a tax provision for 529 plans that allows for the acceleration of the equivalent of five years’ worth of contributions in a single year. For example, you and your spouse may be able to contribute up to $150,000 to a single beneficiary 529 plans ($15,000 x 2 spouses = $30,000 x 5 years = $150,000). The entire contribution in 2018 will be exempt from gift tax and will not use up any lifetime exemption, but a gift tax return needs to be filed to make the frontloading election.

Changes for 2018

The above two paragraphs cover the basics, but what has changed for 2018? Beginning this year, distributions of up to $10,000 per beneficiary can now be used for elementary and secondary high school. This represents a major change in how the usages and funding of 529 plans. Below are some strategies that should be considered:

  • If you live in a state that offers a tax benefit for 529 plan contributions, and you have a child attending private school, you might want to consider using the 529 plan as a pass through for school tuition payments. In the case of New York, contributions up to $5,000 per year by an individual or $10,000 per year by a married couple filing jointly are deductible in computing state income tax. There is nothing preventing a taxpayer from parking up to $10,000 of annual private school tuition in a 529 plan for a short time period to capture the state income tax benefit and paying the $10,000 for private school.
  • If you live in New Jersey, the pass through strategy is not available, as New Jersey does not offer an income tax benefit on contributions. However, if you have private school intentions along with the means to accelerate contributions into a 529 plan, it might make sense to opt for the five year gift acceleration option vs. smaller annual contributions. The main driver to 529 plan success is time. Time allows for the saver to accumulate tax free gains that hopefully compound year after year. With college 18 to 22 years out for a newborn, there is plenty of time to achieve tax free growth with annual gift exclusion savings into 529 plans during a beneficiaries youth. Yet, with Kindergarten beginning at age 5, two things have changed. One, the time horizon between birth and when distribution might potentially begin have shortened and two, the amount of total dollars that might ultimately be spent from the 529 has increased.
  • For families with the financial means to do so, and a likelihood of the child attending private school, it might be advantageous to elect the five year gift acceleration into a 529 plan for a newborn, by depositing $150,000 at once. The risk of overfunding a 529 plan with $150,000 is greatly reduced with the addition of private school costs, and the earlier you can start the clock on potential tax free growth, the better for those distributions that may come out for elementary and secondary school. In summary, this new change has increased the application of the 529 plan for families and widened the range of potential planning benefits. Perhaps some families will begin funding 529 plans for grandchildren who have yet to be born as part of their family education legacy planning, by funding 529 plans for the adult children and then changing the beneficiary to grandchildren at a later date.

If you are considering making significant gifts into a 529 plan, be sure to do it in conjunction with your overall financial plan. We would be delighted to meet with you to review your entire investment, tax, and gifting plan as part of a comprehensive financial projection.

An Illustration

The below graph illustrates frontloading a hypothetical 529 plan with $150,000 at a beneficiaries birth. The graph assumes the investments within the plan grow at 5% per year and it assumes distributions of $10,000/year from Kindergarten until the end of High School, then distributions totaling $170,000 for college. With a total of $130,000 being distributed from K-12, the risk of overfunding the 529 plan has been greatly reduced.

The above chart is not meant to show the performance of an actual RegentAtlantic client. It is meant to show the impact of frontloading a 529 plan and withdrawing funds for elementary school, high school, and college. Actual performance will vary by investor.

Important disclosure information

Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.

Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.

This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.

RegentAtlantic does not provide legal or tax advice. Please consult with a legal and or tax professional of your choosing prior to implementing any of the strategies discussed in this article.

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