Should you have a separate 529 plan to save for K-12?

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Kathryn Flynn

By Kathryn Flynn

November 27, 2018

Families can now use a 529 plan to save and pay for up to $10,000 (per year, per beneficiary) in tuition expenses at private, public and religious elementary and secondary schools. If you’re thinking of using a 529 plan to save for K-12 tuition, you should consider keeping your K-12 savings in a separate 529 plan account from your college savings.

You can open multiple 529 plans for the same beneficiary in different states, or even in the same state. If a beneficiary has multiple 529 plans from the same state, contributions to each 529 plan account will be summed for comparison with the state’s aggregate contribution limit (typically around $500,000), but otherwise the 529 plans will be separate.

K-12 and college savings investment strategies differ

Having dedicated 529 plan accounts for college and K-12 will make it easier to track your progress and maximize the value of your investments. Each 529 plan will have a different investment strategy, due to the different time horizons. 

When setting up a 529 plan for K-12, use a K-12 savings calculator to determine how much you need to save each month in order to meet your goal. The investment earnings will make up a much smaller percentage of the total projected 529 plan account balance for K-12, compared to the 529 plan for college. The longer you hold money in a 529 plan, the greater the benefit you will receive from tax-free compounding. 

However, there are other ways you can maximize the value of your 529 plan when using it to pay for K-12 tuition.

Select appropriate investments for a shorter time horizon

Prior to the Tax Cuts and Jobs Act of 2017, 529 plans could only be used to save for college, and age-based 529 plan portfolios were designed to maximize investments for college. With an age-based 529 plan portfolio, investment allocations automatically shift over time based on the beneficiary’s age. Typically, the plan’s investments start out aggressive (stocks) and as the beneficiary gets closer to college the investments become more conservative (fixed income). 

But, families who are saving for K-12 tuition have a shorter investment time horizon, and therefore less time to absorb the risk associated with investing in stocks. One solution is to explore target 529 plan portfolios that do not automatically adjust. Target portfolios consist of a mix of stocks and bonds based on a desired level of risk, such as conservative, moderate or aggressive. Parents with a newborn who are saving for first grade private school tuition should select a more conservative option than parents of a newborn saving for private high school. You can make changes to your 529 plan investment portfolio twice per year. 

Take advantage of state income tax benefits, if available

Many states offer tax-free 529 plan withdrawals and a state income tax credit or deduction for 529 plan contributions when the funds are used to pay for qualified college expenses. However, not all states offer the same income tax benefits when funds are used to pay for elementary or high school.

For example, New York residents may claim a state income tax deduction for 529 plan contributions up to $5,000 ($10,000 for married couples filing jointly), but only when the money is used for college. Under New York state law, K-12 tuition is considered a non-qualified expense. Parents who use their 529 plan to pay for K-12 tuition will be subject to state income tax on the earnings portion of the distribution and will have to repay any 529 plan state income tax deductions attributable to the distribution. California does not offer an income tax credit or deduction, but non-qualified distributions (including K-12 tuition) are subject to a 2% penalty tax on the earnings portion of the withdrawal. 

In some states where K-12 tuition is considered a qualified expense, you can make a contribution to a 529 plan and immediately take a qualified distribution that will qualify for a state income tax credit or deduction. Parents saving for K-12 can contribute the maximum annual deductible amount (up to the $10,000 withdrawal limit) to a state’s 529 plan where K-12 tuition considered a qualified expense and use a different 529 plan to save for college. By funneling K-12 tuition through a 529 plan and claiming an income tax deduction or credit each year, you will get the equivalent of an annual discount on private school costs at your marginal state income tax rate.

Impact of 529 plans on financial aid for private K-12 schools

The addition of K-12 tuition as a qualified 529 plan expense may affect a student’s eligibility for vouchers and scholarships for K-12 tuition. 

Before the Tax Cuts and Jobs Act of 2017, most private K-12 schools ignored 529 plans in their financial aid formulas, since the money was restricted to paying for college costs. Now that 529 plans can be used to pay for K-12 tuition, some private schools are considering including 529 plan assets as part of their financial aid formulas.

However, if separate 529 plans are used to save for K-12 and college, parents may be able to convince the private school to ignore the 529 plan funds earmarked for college savings in their financial aid formula.

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