529 savings plans are an excellent way to save and invest money for children's education. But what constitutes a "qualified" educational expense? When that question relates to 529 savings plans, the answer may be broader than you think.
Although 529 accounts are often used to pay for a child's college tuition, those funds can also be used for a variety of qualified expenses. In fact, recent changes to federal law under the Tax Cuts and Jobs Act of 2017 have given investors additional options for how they may spend their 529 plan dollars.
Earnings in 529 plans are not taxed under the federal tax code and withdrawals for eligible expenses are tax-free. If withdrawals are used for purposes other than qualified education expenses, the earnings will be subject to a 10% federal tax penalty in addition to federal and, if applicable, state income tax. Please consult with your CPA regarding the tax consequences with 529 savings plans.
Here are a few ways to put a 529 plan to use:
1. Use a 529 to pay for elementary and secondary school tuition
As a result of 2018 tax reforms, parents can use up to $10,000 per child per year of 529 account funds to pay tuition for children attending kindergarten through 12th grade.
Though the tax-free earnings on withdrawals used for such tuition expenses may not be very high, the state tax deduction benefits may be worthwhile. "Immediate state-level tax benefits are what will almost certainly draw more people who are paying private school tuition into 529 accounts. Any family paying private school tuition in a state offering 529 tax benefits would be foolish, financially speaking, not to make use of them," experts at the Brookings Institution said in a report. Tax-advantaged treatment applies to savings used for qualified education expenses. State tax treatment varies. Currently, New Jersey is working through a proposal that will allow households (who earn up to $200,000 per year) to deduct up $10,000 per year from taxable state income if they make contributions to a New Jersey Better Education Savings Trust (NJBEST) 529 plan. In New York, households can deduct up to $10,000 per year (if they file married filing jointly) of 529 contributions. And in Pennsylvania, households can deduct up to $30,000 per year (again, if they file married filing jointly), per beneficiary. Please consult with your CPA about the tax deductions with 529 savings plans.
A word of caution – families should keep in mind that using 529 funds for a child's elementary and secondary school tuition will eat away at the potential long-term earnings growth, taking away the ability to fund college tuition and related expenses. 529 plans are intended to provide long-term, tax-free compound growth.
2. Use a 529 to pay for vocational school, community college, online courses, and graduate programs
Though many people associate 529 plans with college tuition, they can also be used to fund tuition and other qualified educational expenses at a variety of post-secondary institutions and programs, including community colleges, trade and vocational schools, graduate schools, certain apprenticeship programs and qualifying online course and degree programs. To determine whether a school or program is eligible for 529 spending, check with its admissions office or search the U.S. Department of Education's accreditation database. Qualified education expenses include fees, books, supplies, and equipment required for the participation of a designated beneficiary in certain apprenticeship programs.
3. Technology and internet access can be 529 qualified expenses
In this digital age, education and technology go hand in hand. Fortunately, 529 withdrawals can cover "the cost of the purchase of any computer technology, related equipment and/or related services such as Internet access," according to the IRS. The type of equipment covered includes printers and computer software used for educational purposes.
4. Prepare for a career change by creating a 529 for yourself
529 plans aren't just for kids and teens. Adults can set up 529s to cover their own educational expenses, which may prove handy to those pursuing a change of careers.
There are a couple of ways adults can take advantage of 529 plans. The most direct way is to open new accounts and designate themselves as the beneficiaries. Parents can also "take over" existing 529 plans that once benefited their children. For instance, if a child wins a scholarship and her college expenses prove lower than originally anticipated, a new beneficiary in her family — including her parent — can be designated for the account and use its excess funds without facing a tax penalty.
5. 529 plan contributions are tax-advantaged gifts
Relatives and friends can use 529 plans to give gifts to the children in their lives. Grandparents, aunts and uncles or anyone else wishing to help fund a child's education may contribute to an existing 529 account or open a new one and name the child as the beneficiary. In many states, those contributions can be deducted from state income taxes, although gift-givers should remember that gift taxes may apply to contributions exceeding the annual exclusion of $15,000 per recipient.
529 gifts, however, come with a special tax exemption: Individuals can contribute up to $15,000 ($30,000 for married couples) annually without gift-tax consequences. Under a special election, you can invest up to $75,000 ($150,000 for married couples) at one time by accelerating five years' worth of investments. This might be an especially attractive option for those intent on minimizing future estate taxes or anyone contributing cash to a student who could use the funds right away.
Today, more than ever, 529 plans can help investors and their children achieve a range of educational and career goals. If you have any questions or would like to talk more about your current financial situation and goals, we would be delighted to meet with you in-person or virtually. Please call us at 908-379-2713 or email me at Tim@WestfieldFinancialPlanning.com.