Expand Tax Benefits of 529 Plans

Thanks to the new Tax Cuts and Jobs Act (TCJA), parents of younger kids can use a tax-favored technique previously reserved for college students.

Strategy:  Tap into a Section 529 plan to pay pre-college tuition.  The TCJA expands the special tax exemption for distributions from such plans, within limits, for children in kindergarten through grade 12.

The new tax break applies to distributions from Section 529 plans made after 2017.  Unlike many provisions for individuals, this tax law change in permanent.

Here’s the whole story:  A 529 plan is an educational savings plan, operated by one of the states, that was initially used only to pay for college expenses.  As long as certain requirements are met, there’s no federal income tax on the accumulation of earnings within the plan, plus qualified distributions are exempt from federal tax.

If the child completes school, decides not to enter college or leaves early, you can roll over the plan assets tax free to an account for a different beneficiary, like a younger child or grandchild.

Thus, a 529 plan can continue indefinitely.  For instance, someone might initially establish a section 529 account for a child and then switch the named beneficiary to a grandchild.  Other rollovers may be available.

The list of qualified higher education expenses used for college includes:

  • Tuition and fees
  • Books
  • Supplies
  • Equipment
  • Reasonable costs for room and board

New law change:  Under the TCJA, the tax exemption is expanded to include annual distributions of up to $10,000 to cover tuition payments to an elementary or secondary public, private or religious school.  Thus, if your family has a long tradition of attending a prestigious college prep school or other academy, you can use section 529 plan distributions to pay part of the tuition at the institution for your child.

Note that an early draft of the TCJA also excluded from tax amounts used to cover home schooling costs.  But this provision was removed from the final version of the law.

Finally, be aware that amounts contributed to a section 529 account are sheltered from gift tax by the annual gift tax exclusion.  For 2018, you can give up to $15,000 a year—$30,000 for joint gifts made by a married couple—to an account for the beneficiary with zero gift tax.

Icing on the Cake:  You can load up on 529 plan contributions in the first year.  The tax law allows you to benefit from five years’ worth of annual gift tax exclusions if you want to make a generous lump-sum 529 plan contribution in one year with no gift tax consequences.

The gift is treated as if it were spread out over the five year period.  For example, you and your spouse can contribute up to $150,000 for one child or grandchild this year without any gift tax consequences.

Tip: Any excess above the gift tax exclusion can be sheltered by the gift tax exemption ($11.18 million in 2018, or effectively $22.36 million for married couples).

Small Business Tax Strategies (August 2018)