Final GOP tax bill expands 529 plans: Here's who will benefit

http://www.savingforcollege.com/articles/final-gop-tax-bill-expands-529-plans-heres-who-will-benefit

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As a last-minute amendment to the Tax Cuts and Jobs Act, Sen. Ted Cruz (R-Texas) added a provision to allow families pay for up to $10,000 per year of K-12 expenses with a 529 plan. This inclusion is said to be a major victory for advocates of President Trump and Betsy Devos's school choice agenda, but many argue that the potential tax savings would only help high-income families who can afford to pay for private school.

The reality is, some (but certainly not all) families will benefit from the amendment - mainly those who send their children to private schools. But remember, it's not just the 1% who use private schools. And the bill also includes a provision that would help people living with a disability. Here's a summary of the types of families that would see the biggest impact:

1. Families who send their children to private high school
   529 plans are investment accounts that offer tax-free earnings growth. The national average tuition costs at private high schools in the United States is just over $13,000 per year, according to the Private School Review. In 14 years, if tuition prices rise 2.5% per year, the total four-year cost of attendance would be around $76,000.

   Let's say a family earning $150,000 per year wants to start saving for private high school when their child is a newborn. They contribute $300 each month to a 529 plan, where their earnings grow tax-free over the next 14 years. Assuming an annual investment return of 6%, they would be able to save $75,654. If the same family saved in a taxable account, they would only end up with $67,315 ($8,339 less).

2. Families that live in a state that offers a 529 tax benefit
   In addition to federal tax savings, 34 states and the District of Columbia offer a state tax deduction or credit for 529 plan contributions. Most of these states require residents to use their home states plan to qualify, but Arizona, Kansas, Minnesota, Missouri, Montana and Pennsylvania offer a tax benefit for contributions to any states 529 plan.

   That means some parents will be able to take a state tax deduction for the entire amount they pay each year in private school tuition. Take Missouri, for example. Contributions to a 529 plan of up to $16,000 per year (for married couples filing jointly) are deductible in computing state taxable income. The average cost of private school annual tuition in Missouri is $6,777 for elementary school. Whether parents are using savings or income to pay tuition, it makes sense to funnel the money through a 529 plan first so that they can claim the state tax benefit. Keep in mind that the average cost of high school in this state is just over $12,000. In this case, parents can still contribute the maximum deduction amount, but they can only withdraw up to $10,000 to pay for high school. Since Missouri is a tax parity state, parents should compare 529 plans to find the best combination of low fees and consistent performance history.

   Families may want to consider contributing up to the amount of the maximum state tax deduction each year, and leaving the excess funds in the account to grow tax-free to pay for college. If they are using a 529 plan to save for college, they should consider opening a separate account for K-12 savings. Many 529 accounts use an age-based portfolio that is designed to automatically shift from equities to fixed income investments as the beneficiary gets closer to college. A K-12 savings account would ideally consist of investments designed for a shorter time horizon.

3. Families who currently save with a Coverdell ESA
   Currently, the only way to save tax-free for K-12 education is with a Coverdell Education Savings Account. With a Coverdell ESA, you'll get the same tax-free growth as you would with a 529 plan - but there are no state tax benefits, regardless of where you live. Parents using this type of account have a couple of options:

   1. Save with a Coverdell ESA and a 529 plan: Annual contribution limits to a Coverdell ESA are limited to $2,000 per year, per beneficiary. That means a family with a newborn would only be able to save about $44,000 in the 14 years until high school – just over half of the projected total average cost. Parents can open a 529 plan to save for the additional costs, and, if they qualify, claim a state tax benefit. There are no annual contribution limits for 529 plans, and up $14,000 will qualify for the annual gift tax exclusion ($15,000 in 2018). Keep in mind that the future of Coverdell ESAs is uncertain - the House version of the GOP tax bill included a provision to eliminate them, but they were not mentioned in the revision submitted by the Senate.

   2. Transfer the funds to a 529 plan: Assets in a Coverdell ESA can be rolled over into a 529 plan without any tax consequences. If parents can use a 529 to save for K-12 education, they may want to consider a rollover, especially if there's a chance they will end up with leftover money in the account after tuition is paid. Funds in a Coverdell ESA must be withdrawn by the time the beneficiary turns 30, otherwise any gains in the account will subject to income tax and a 10% penalty tax. With a 529 plan, anything that's not used to pay for K-12 education can be saved for college, and anything not used to pay for college can be saved for graduate school or even a grandchild.

4. Students living with a disability
   The final version of the GOP tax bill also includes a provision to allow traditional 529 plans to be rolled over into ABLE accounts. ABLE accounts allow people living with a disability to save up to $14,000 per year ($15,000 in 2018) as a supplement to private insurance and public benefits like Medicaid. Prior to the ABLE Act in 2015, a person who earned more than $700 per month or had more than $2,000 in assets risked having to forfeit eligibility for government assistance.

   Today, 27 states and the District of Columbia offer ABLE plans, the majority without residency requirements. Qualified ABLE account expenses include education costs, job training and support, healthcare and financial management. Since many of these costs are paid throughout the year, most plans offer a debit or purchasing card to use toward qualifying purchases.

   The final tax bill is a major game changer for the education savings industry and strengthens the case for many families to use 529 plans. It's important to understand how to maximize potential tax benefits depending on the situation.