A 529 plan is a savings account that is set up to offer tax-advantages for those who invest in their children's higher educational expenses. These plans have evolved over the years, most recently with the passage of the Tax Cuts and Jobs Act (TCJA) at the close of 2017.
One big change that came with the tax reform of the TCJA: 529 plans extend beyond college savings.
How did tax reform change 529 plans? Due to the passage of the TCJA, 529 plans were no longer limited to college expenses. The TCJA expanded these plans to apply to qualifying expenses incurred in private, public and religious schools that range from kindergarten to 12th grade. In addition, students refunded tuition (for example, due to dropping a class) can avoid income taxation on the refunded amount if the refund is recontributed to the 529 account within 60 days of receipt. Future Treasury Regulations will also clarify that the beneficiary's maximum lifetime contribution limit is not impacted by recontributed refunds.
How can I make the most of the new 529 plans? Although this change has increased the flexibility of these plans, pitfalls remain. Four specific mistakes to avoid when investing in a 529 plan include:
- Stack your contributions. Even though contributions to the 529 plan are part of your annual, $15,000, gift tax exclusion. You can bunch up or stack the 529 plan by giving up to $70,000 ($140,000 for married couples joining in the gift) in a single year. It is considered to have been proportionally made over five years; thus, future annual exclusion gifts are affected.
- Failure to read the fine print. This specifically applies to the provision regarding withdrawals from the 529 plan. The TCJA currently sets a limit on withdrawals at $10,000 per year, per child. Penalties apply for withdrawals over this limit.
- Impact of state laws. The TCJA is a federal tax law. The passage of this law does not guarantee state sponsored plans will adopt the same rules. A recent piece in U.S. News notes less than half of the states have confirmed adoption of these new rules. As such it is wise to confirm the state that sponsors your 529 plan has adopted the new rules before changing your investing strategy.
- Confusion about state tax deduction. Some state 529 plans offer taxpayers a deduction for contributions. The changes resulting from the TCJA make it much more likely taxpayers will make contributions and withdrawals during the same tax year. It is unclear how states will react.
These are just three issues to navigate to help better ensure you get the most of your 529 plan gift and investment strategies. An attorney experienced in these matters can provide additional guidance and better ensure you do not run afoul of applicable tax laws and face unexpected tax penalties in the future.