How Tax Reform Changed 529 Plans
On December 22, 2017, the President signed into law H.R. 1, the “Tax Cuts and Jobs Act,” a sweeping tax reform law that promises to entirely change the tax landscape. One of the biggest beneficiaries of this change are individuals who own 529 plans. This article will take a look at the basics with a 529 plan, dive into the weeds and then take a look at how this tax reform expanded the use of 529 plans.
The 529 plan was created by Congress in 1996 and they are named after section 529 of the Internal Revenue Code. Anyone can set one up a 529 and name anyone as a beneficiary — a relative, a friend, even yourself. There are no income restrictions on either you, as the contributor, or the beneficiary. The funds in a 529 plan grow tax-deferred and as long as they are used for “Qualified higher education expenses” the money taken out of a 529 plan is tax-free.
Contribution amounts - One of the many benefits of saving for a child's future college education with a 529 plan is that contributions are considered gifts for tax purposes. In 2018, gifts totaling up to $15,000 per individual will qualify for the annual exclusion. This means if you and your spouse have three grandchildren you can gift $90,000 without gift-tax consequences since each child can receive $15,000 in gifts from you and $15,000 in gifts from your spouse. If your total gifts to an individual will be more than $15,000 this year, the excess amount will have to be reported on Form 709 when you file your taxes in 2019. There is no joint gift-tax return, so you and your spouse will each have to file separately.
The 5-year election - You may have read that you can contribute as much as $75,000 to a 529 plan without incurring gift taxes. This is absolutely true, as long as your contribution is at least $15,000 and you spread it over a five-year period. The amount will be pro-rated over the next five years, so if you deposit $50,000 it will be applied as $10,000 each year, leaving you with $5,000 in unused annual exclusion. This is often a great estate-tax planning strategy for grandparents. They're able to shelter a large number of assets from estate taxes while retaining control of the funds in the 529 accounts. However, if you do end up changing your mind down the road and revoking the funds in the account they will be added back to your taxable estate.
529 plan limits - Unlike IRAs or 401(k)s, there are no annual contribution limits for 529 plans. However, there are maximum aggregate limits, which vary by plan. Under federal law, 529 plan balances cannot exceed the expected cost of the beneficiary's qualified higher education expenses. Limits vary by state, ranging from $235,000 to $520,000. This amount represents what the state believes to be the full cost of attending an expensive school and graduate school, including textbooks and room and board. If your plan is close to the limit don't worry about future earnings in the account pushing it over. The funds can remain in the account without penalty, but the family will not be able to make any future contributions unless a market drop brings the account balance back down.
Changing the beneficiary – Yes, there are no tax consequences if you change the designated beneficiary to another member of the family. Also, any funds distributed from a 529 plan are not taxable if rolled over to another plan for the benefit of the same beneficiary or for the benefit of a member of the beneficiary’s family. So, for example, you can roll funds from the 529 for one of your children into a sibling’s plan without penalty.
How this tax reform expanded the use of 529 plans
Under pre-Act law, funds in a Code Sec. 529 college savings account could only be used for qualified higher education expenses. If funds were withdrawn from the account for other purposes, each withdrawal was treated as containing a pro-rata portion of earnings and principal. The earnings portion of a nonqualified withdrawal was taxable as ordinary income and subject to a 10% additional tax unless an exception applied. “Qualified higher education expenses” included tuition, fees, books, supplies, and required equipment, as well as reasonable room and board if the student was enrolled at least half-time. Eligible schools included colleges, universities, vocational schools, or other postsecondary schools eligible to participate in a student aid program of the Department of Education. This included nearly all accredited public, nonprofit, and proprietary (for-profit) postsecondary institutions.
Under the new law, for distributions after Dec. 31, 2017, “qualified higher education expenses” include tuition at an elementary or secondary public, private, or religious school. (Code Sec. 529(c)(7), as added by Act Sec. 11032(a))
You heard that right ladies and gentlemen! Simply put, starting in 2018, qualified educational expenses for 529 plans * will include up to $10,000 a year in tuition and expenses for primary and secondary school expenses (public, private, or religious). Previously, you could only use it towards qualified college expenses. With education costs from elementary school through college on the rise, setting up a 529 plan today can be the smartest investment you make for your child’s future education.
* Prior to investing in a 529 Plan investors should consider 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. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
Securities offered through LPL Financial, Member FINRA/SIPC.
Investment advice offered through Gerber Kawasaki Inc, a registered investment
advisor and separate entity from LPL Financial.
The opinions voiced in this material are for general information only and are not
intended to provide specific advice or recommendations for any individual. To
determine which course of action may be appropriate for you, consult your
financial advisor. No strategy assures the success or protects against loss.
Gerber Kawasaki, 2716 Ocean Park Blvd. #2022 Santa Monica, CA 90405.
Contact us at (310) 441-9393.