In December 2017, the Tax Cuts and Jobs Act became law, affecting virtually all taxpayers. One provision that made the final cut – and that may have an impact on your financial plans – was the expanded use of 529 plans.
Expansion of 529 plans to allow K-12 expenses
Under the new law, the definition of a 529 plan "qualified education expense" has been expanded to include K-12 expenses. Starting in 2018, annual withdrawals of up to $10,000 per student can be made from a 529 college savings plan account for tuition expenses in connection with enrollment at an elementary or secondary public, private, or religious school (excluding home schooling). Such withdrawals are now tax free at the federal level.
Roughly 20 states automatically updated their state legislation to align with federal 529 legislation, but the remaining states will need to take legislative action to include K-12 expenses as a qualified education expense and, if applicable, extend other state tax benefits to K-12 expenses. Account owners should understand their state’s rules regarding how K-12 funds will be treated for tax purposes.
In addition, account owners should check with the 529 plan administrator to determine whether a K-12 withdrawal request should be made payable to the account owner, the beneficiary or the K-12 institution. It's likely that 529 plans will further refine their rules to accommodate the K-12 expansion and communicate these rules to existing account owners.
The expansion of 529 plans to allow K-12 expenses will likely impact Coverdell Education Savings Accounts (ESAs). Up until now, they were the only game in town for tax-advantaged K-12 savings. Now the use of Coverdell ESAs may decline as parents are likely to prefer the much higher lifetime contribution limits of 529 plans — generally $350,000 and up — compared to the relatively paltry $2,000 annual contribution limit for Coverdell accounts.
However, Coverdell owners have a lot of flexibility in terms of what investments they hold in their account, and they may generally change investments as often as they wish. By contrast, 529 account owners can invest only in the investment portfolios offered by the plan, and they can exchange their existing plan investments for new plan investments only twice per year.A list of 529 plans offered, by state, and a comparison tool are available at collegesavings.org.
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Before investing, investors should carefully consider the investment objectives, risks, charges and expenses of the 529 Plan. This and other important information is contained in the issuer's official statement, and the prospectuses, or if available, summary prospectuses, all of which may be obtained from your financial advisor. Please read them carefully before investing.
An investor should consider, before investing, whether the investor's or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state's qualified tuition program
Investment return and principal value will fluctuate, and it is possible to lose money by investing. Investing involves risk and the potential to lose principal and there is no guarantee that any investment strategy will be successful.
Earnings portion of any withdrawal not used at an eligible institution for qualified expense is considered income and subject to federal and possibly state income tax plus a 10% federal tax penalty on the earnings.
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