Tax Law Changes Affect College Savings Plans

On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act into law. The bill presents many changes to the United States tax code, including a new provision that allows for $10,000 to be withdrawn annually from 529 savings accounts. These funds can be used for private school tuition and are tax free.

What is a 529 Account?

This account is a special savings plan to help parents manage college tuition later on. It is a vital investment for many people, which means the changes in the tax law will have far-reaching effects. On the surface, the law's expansion for private school seems too good to be true. The complete implications are unknown until private schools and state governments respond to the changes.

Federal Level

The following list explains the benefits of a 529 savings plan on the federal level before the new provisions.

• Anyone at any income level can start and contribute to a 529 plan
• The funds placed in a 529 cannot be deducted on the federal tax return
• All funds that are withdrawn from the 529 to be used for qualifying costs (such as books, tuition and living expenses) are not subject to capital gains tax

As of January 1, 2018, all of the above remains in effect with the addition of the $10,000 provision for private school expenses, which can be used for kindergarten through 12th grade. At this level, the changes are clear, but private schools and state governments may put forth their own provisions going forward.

State Level

While 529 accounts are easy to understand at the federal level, the administration of them is handled by the states. Every state has its own rules and specific benefits in regard to 529 accounts held by residents. The most common benefits on the state level are tax credits and deductions for contributions. In most cases, these particular benefits can only be applied to 529 accounts within the state, but there are exceptions to this.

It is possible that if more people start 529 accounts or are able to contribute to them for a longer period of time, states may either reduce or place a cap on the benefits in order to protect tax revenue. In addition, the 2018 provisions may lead to parents choosing a private school over a public one. This could result in a drop in enrollment and a loss of funding. States may then choose not to provide subsidies that support this scenario. Although each state could separate the 529 funds for private schools from the funds used for college, it would create a large and expensive administrative issue.

Private Schools

In previous years, 529 plan funds could not be used for private school tuition, which was reflected when the school created a financial aid package for a student. It is not known what will happen when families exercise the benefits of the new provision. Private schools will be forced to adjust by shifting their formula for financial aid. It is also unclear what the impact will be on families that can already afford private school for their children.

What Parents Can Do

Parents who have a child currently attending private school will likely see only minimal benefits with the new provision. In order to explore all of their options, families should consult with a financial advisor to find the right strategy. For those who have a 529 for college expenses, it is possible to withdraw funds for private school but at the risk of losing the tax-free advantage. By taking funds out early, families may also feel the impact when it is time for college. Those with small children should continue to save with a 529 as usual.

The new Trump plan has proven that shifts in the tax law can occur at any time and have a large impact on saving and investing. Parents should proceed cautiously with 529 accounts to ensure they are not overfunded as the 2020 administration could introduce even more changes. Non-qualified contributions to 529 accounts carry a penalty of 10 percent, which can be a painful hit over the long term.

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