Big Changes to College Savings Plans

Article Highlights:

  • Sec. 529 Plans
  • Saving for College
  • Elementary and Secondary School Tuition
  • ABLE Account Transfers

Tax reform added some new taxpayer-advantageous changes to college savings plans. These plans are also known as qualified tuition programs (QTPs) or Sec. 529 plans, named after the part of the Internal Revenue Code that established them.

Background: Sec. 529 plans allow taxpayers to put away larger amounts of money than other tax-advantaged education savings plans do, limited only by the contributor’s gift tax concerns and the contribution limits of the intended plan. There are no limits on the number of contributors, and there are no income or age limitations. The maximum amount that can be contributed per beneficiary (the intended student) is based on the projected cost of college education and will vary between the states’ plans. Some states base their maximum on the projected costs of an in-state four-year education, but others use the cost of the most expensive schools in the U.S., including graduate studies. Most have limits in excess of $200,000, with some topping $370,000. Generally, additional contributions cannot be made once an account reaches the state’s maximum level, but that doesn’t prevent the account from continuing to grow.

Although the plans are authorized by the various states, it is not necessary for the plan to be set up in the future student’s home state, and the student isn’t restricted to using the funds to attend college in their home state or the state where the plan was set up. Some states provide state income tax incentives to the plan’s contributors, such as a state income tax deduction or a tax credit for contributions to the state’s 529 plan.

When the time comes for college, the distributions will be part earnings/growth in value and part contributions. The contribution part is never taxable, and the earnings part is tax-free if used to pay for qualified college expenses. In addition to a tax-free distribution from the 529 plan, a taxpayer may claim an education credit – such as the American Opportunity Tax credit, which can be as much as $2,500 – in the same year, provided the same expenses aren’t used for both benefits and the taxpayer’s income level does not phase out the credit.

The big advantage of a Sec. 529 plan is tax-free accumulation, so the sooner the account is established and funded, the better. A special provision of Sec. 529 allows those who are concerned with the annual gift tax limitations, currently $15,000, to contribute five years’ worth of contributions ($75,000) up front. These limitations apply to each contributor, but if there are multiple contributors, such as parents, grandparents, aunts and uncles, huge amounts can be contributed up front and provide the greatest long-term growth.

Tax Reform Changes: Under the recent tax reform, the use of Sec. 529 plan funds was expanded to include:

Elementary and Secondary School Tuition – As of 2018, tax-free distributions of up to $10,000 per year per designated beneficiary are allowed for tuition (no other expenses are allowed) in connection with enrollment or attendance at elementary or secondary schools, including public, private and religious schools. However, this option should be considered cautiously, since Sec. 529 plans work best when the money put into the plan is allowed to grow for a long period of time. For less well-to-do families who can’t afford to frontload their 529 plan contributions, making pre-college withdrawals will defeat the long-term tax-free accumulation benefit and could deplete the account before the student even starts college. It should be noted that while this tax reform change applies for federal purposes, some states are still limiting qualified distributions from their plans to only those used for college expenses.

Sec 529 to ABLE Account Transfers – Tax reform also provides that a distribution from a Sec. 529 qualified tuition plan account is tax-free and penalty-free if it is rolled over within 60 days to an ABLE account of the same designated beneficiary or a member of the designated beneficiary’s family. This rollover provision is only available through 2025. The amount of the rollover is limited, when combined with other contributions, to the annual maximum.

Qualified ABLE programs provide the means for individuals and families to contribute and save for the purpose of supporting individuals who became blind or severely disabled before turning age 26, in maintaining their health, independence, and quality of life.

Example: Bill, who finished school and graduated, still has $8,000 in his Sec. 529 qualified tuition plan that his parents had set up to pay his college tuition. Bill will no longer have any education expenses, so he rolls the balance of his Sec. 529 plan into his 14-year-old blind niece’s ABLE account within the 60 days allowed. There are no taxes or penalties on the rollover. However, since contributions to the ABLE account are limited to $15,000 (2018), others may only contribute an additional $7,000 ($15,000 − $8,000) to the niece’s ABLE account. 

If you have any questions about how Sec. 529 plans and the changes made to them by tax reform might affect your specific circumstances, please call.

Tax Reform Adds Education Benefit

Article Highlights:

  • Tax Benefits
  • Types of Tax-advantaged Education Savings Plans
  • Differences in Permitted Contributions
  • Differences in Qualified Education
  • New $10,000 Allowance

Note: This one of a series of articles explaining how the various tax changes in the GOP’s Tax Cuts & Jobs Act (referred to as “the Act” in this article), which passed in late December of 2017, could affect you and your family, both in 2018 and in future years. This series offers strategies that you can employ to reduce your tax liability under the new law.

Tax law provides two tax-advantaged savings plans for the Qualified State Tuition Plan (commonly referred to as a 529 Plan). They are similar in that contributions to the plans are not tax deductible (although some states do allow a deduction for contributions to their plans) and the earnings are tax deferred and tax free if used for qualified education expenses.

They are different in that only $2,000 per year can be deposited into a Coverdell account, whereas contributions to a 529 plan are only limited by gift tax considerations and the cost of attending the state’s highest-cost university. This generally means the annual contribution to a 529 plan is limited to the annual gift tax exclusion amount ($15,000 for 2018) in order to avoid gift tax complications. However, the annual gift limit is per contributor and multiple individuals, typically grandparents, can also contribute to a 529 plan. On the other hand, a maximum of only $2,000 can be contributed to a Coverdell account regardless of the number of contributors. Thus, 529 plans typically accept the largest amount of college savings funds.

Another difference has been that Coverdell accounts can be used for education in kindergarten and above, while 529 plans can only be used for post-secondary education. As a practical matter, the $2,000 annual Coverdell contribution limits don’t provide for a substantial amount of savings that can be used for early childhood education.

To alleviate that disparity, the Act amended the 529 plan rules to allow, beginning in 2018, up to $10,000 of 529 plan funds to be used federally tax-free annually, per student, for elementary school and high school education expenses. In addition the funds can be used to cover the expenses of attending public, private and religious schools. However, some states have not yet adopted the Act’s law change or may need to change the language in their tax codes that define the accounts as “college” savings plans before distributions for elementary and secondary school expenses will qualify as totally state tax free. States that have allowed a deduction for contributions to their plans may decide to scale back some of the tax benefit if distributions are used for expenses in grade K-12.

Both a Coverdell and a 529 plan can be established for the same student, and the combination allows more funds to be accumulated.

For additional details or assistance in planning for a child’s higher education, please give this office a call.