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529 plans aren’t just for college anymore. The Tax Cuts and Jobs Act of 2017 expanded 529 plan benefits to include tax-free withdrawals for K-12 tuition. Here are some things to consider when using a 529 plan to pay for elementary and secondary school.
Rules for Using a 529 Plan to Pay for K-12 Tuition
529 plans offer the same federal tax advantages whether you use the funds to pay for college or K-12 tuition. Investments in the account grow on a tax-deferred basis, and withdrawals are tax-free. You may also qualify for a state income tax deduction or credit, depending on where you live.
However, unlike withdrawals for college, qualified K-12 expenses are limited to $10,000 per year. If you withdraw more than that amount, you will incur income tax and a 10% penalty on the earnings portion of the excess distribution.
Another important thing to remember is that only K-12 tuition is considered a qualified expense. You may not take a tax-free 529 plan distribution to pay for other K-12 expenses, such as school supplies, uniforms or room and board. Qualified college expenses, on the other hand, include tuition, books, supplies and equipment, computers, some room and board costs and more.
The availability of tax or other state benefits (such as financial aid, scholarship funds and protection from creditors) may be conditioned on meeting certain requirements, such as residency, purpose for or timing of distributions, or other factors.
The earnings portion of non-qualified withdrawals is subject to federal and state income taxes and a 10% federal penalty.
When Does it Make Sense to Use a 529 Plan to Pay for K-12?
529 plans offer greater potential federal tax savings when they are used to pay for college. But, in some cases it may make sense to use a 529 plan to pay for K-12 tuition.
For example, some families end up with leftover money in their 529 plan. Believe it or not, it is possible to save too much for college. Your child may decide to go to a less expensive school than planned, or choose an entirely different path. Instead of taking a non-qualified distribution, you can keep your tax savings and use your leftover funds to pay for a younger sibling’s K-12 tuition.
In certain states, taxpayers can make a 529 plan contribution and immediately take a qualified distribution that is eligible for a state income tax deduction or credit. Parents can funnel K-12 tuition payments through a 529 plan and claim the income tax benefit, effectively getting a discount on private school costs. Depending on your state income tax rate, this could lead to substantial savings. However, keep in mind that some states limit 529 plan tax benefits to college expenses only. In these states, distributions to pay for elementary and secondary school tuition are considered non-qualified and may be subject to state income tax and recapture of any state income tax benefits claimed. (California also charges a 2.5% state penalty tax for non-qualified distributions).
529 plans also offer benefits for grandparents who want to help pay for private education. Contributions to a child’s 529 plan are considered completed gifts for tax purposes, and qualify for the annual gift tax exclusion ($15,000 in 2021). Grandparents can also avoid future gift taxes by electing to spread a large, one-time contribution (up to $75,000) over five years. But, remember that qualified withdrawals for K-12 tuition are limited to $10,000 per year. Anything beyond that amount can be saved for college.
Grandparents may also be eligible for a state income tax deduction for 529 plan contributions. For example, Kansas taxpayers are eligible to deduct up to $3,000 ($6,000 if married filing jointly) for 529 plan contributions per child from state taxable income. Check your state’s rules for specific details and eligibility.
Many 529 plans, including Kansas’s LearningQuest 529, offer simple ways to ask for and receive 529 plan contributions as gifts from grandparents and other loved ones.
How to Use a 529 Plan to Pay for K-12 Tuition
Families who use a 529 plan to pay for K-12 tuition should consider their shorter time horizon when selecting an investment portfolio.
Many 529 plans offer age-based investment portfolios that were designed to maximize investments for college. These portfolios often start out heavily invested in stocks and become more conservative over time. However, if you are using a 529 plan to pay for K-12 tuition, you will have less time to absorb the risk associated with investing in stocks. A better solution may be an enrollment-date portfolio or a target portfolio that is based on a specified level of risk and does not automatically adjust.
Since you will likely use different investment strategies for college savings and K-12 tuition, you may want to consider having separate 529 plans. There is no limit to the number of 529 plans you can have per beneficiary, and you don’t have to use 529 plans from the same state.
A K-12 savings calculator can help you determine how much you’ll need to put away each month. Remember, because of the shorter time horizon, the investment earnings will make up a much smaller percentage of your account balance for K-12. But, you may be able to funnel tuition payments through the 529 plan to claim a state income tax benefit.
The longer you keep funds in your 529 plan account, the greater your potential tax savings will be. However, there are still some nice incentives for families who want to withdraw funds to pay for K-12 tuition.
Before investing, carefully consider the plan’s investment objectives, risks, charges and expenses. This information and more about the plan can be found in the Learning Quest Handbook, available by contacting your financial advisor or American Century Investment Services, Inc., Distributor, at 1-800-579-2203, and should be read carefully before investing. If you are not a Kansas taxpayer, consider before investing whether your or the beneficiary’s home state offers a 529 plan that provides its taxpayers with state tax and other benefits not available through this plan.
Notice: Accounts established under Learning Quest and their earnings are neither insured nor guaranteed by the state of Kansas, the Kansas State Treasurer or American Century.
No additional gifts can be made to that beneficiary over the next four years after the year in which the one-time gift is made.
If the donor of an accelerated gift dies within the five-year period, a portion of transferred amount will be included in the donor’s estate for estate tax purposes. Consult with a tax advisor regarding your specific situation.
IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.
This information is for educational purposes only and is not intended as tax advice.
Administered by the Kansas State Treasurer, Lynn Rogers.Managed by American Century Investment Management, Inc.
American Century Investment Services, Inc., Distributor
4500 Main St., Kansas City, MO 64111
