Posted May 9, 2018
Since the creation under the Small Business Protection Act of 1996, 529 accounts have allowed savers to contribute after-tax dollars for the purpose of paying education expenses to the beneficiary. The money is invested and can grow tax-free. Withdrawals are tax-free if used for education expenses such as college tuition, books, room and board.
Unlike Coverdell Education Savings Accounts (ESA), which are also designed for education expenses, 529 plans allow different people to contribute up to $15,000 per year and avoid filing a gift tax-return. For example, mom and dad each may contribute $15,000 per year, and the same for grandparents. If these contributors max out every year, the beneficiary could be receiving $60,000 per year in college savings from four different individuals. In contrast, contributions to a specific beneficiary’s Coverdell account are limited to $2,000 per year.
Anyone can contribute to a 529: other relatives, friends, even strangers. These plans are popular and have grown to $275 billion in assets nationwide. Additionally, the beneficiary can be changed without penalty if, for example, the original student receives a scholarship and does not use the full balance.
Until the passing of the new tax law, Coverdell ESAs boasted an additional opportunity that 529s did not: the money could be used for educational expenses in grades K-12. But due to the new tax law, 529s now overlap in this regard: the money can be used for K-12 private school tuition, for up to $10,000 per year for each student.
The downside to this new flexibility is a shorter time horizon for the investments to grow. Under the old rules, 529 plans which started at birth had 17 to 18 years of investment growth before withdrawals would begin. Now, if withdrawals begin with private kindergarten, the investment time horizon before withdrawals may be only five years. Time is a diversified investor’s best friend; the more the better.
Most 529 plans are offered by states, and most states have them. Investors are not limited to the 529 plan offered in their state and may change to a different plan. For example, at Bell Investment Advisors we prefer the Virginia plan through American Funds because of a robust menu of great options, flexibility in adjusting the portfolio as the beneficiary ages, and no-load, low expense funds.
Each 529 plan has different rules in each state, so it is important to check with your plan provider to make sure K–12 withdrawals are allowed. In most cases, they are allowed, but New York State warns that K–12 withdrawals may have state tax consequences. New York state is still evaluating the new law. Even if you have a 529 plan and the beneficiary is attending private school before college, you are not required to use 529 plan assets for K–12 tuition. You may choose to take advantage of the longer investment time horizon.
Source: Wall Street Journal 2/14/2018
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The 2018 tax season is now upon us, and with that comes tax documentation to assist you in filing your return. All official tax reporting information will come directly from Schwab. Please see below for timelines (varies by document type). 1099 – Paper Mailing For retirement accounts, you should have already received your Form 1099-R. …Read More