Many parents and loved ones are concerned about funding their children’s education, and it’s no wonder. According to College Board’s recent “Trends in College Pricing” report, average tuition to attend a public four-year institution has increased 213% from 30 years ago. However, there is an option to help with these costs – the 529 plan.
Currently there are two types of Qualified Tuition Programs under IRC Section 529(b)(1)(A): prepaid tuition and college savings investment plans.
Prepaid Tuition vs. College Savings Investment Plan
Those who open a prepaid tuition plan generally lock in the current costs of tuition in place of future prices, which generally rise every year. Historically, these plans have been popular, but as several states’ prepaid tuition plans have stopped accepting new enrollees or shut down entirely over the past few years, college savings investment plans have grown in popularity.
The decreased popularity of prepaid plans may be due in part to some drawbacks. For example, money put into several state-run prepaid plans may only be applied to tuition and fees at in-state public colleges and universities. The good news is that here in Washington, the Guaranteed Education Tuition (GET) units can be used at nearly any public or private college, university, or technical school in the U.S. and at selected colleges in other countries. However, it should be noted that room, board, books, and other expenses are not included and must be covered separately.
Maximum annual contributions continue to be subject to the federal gifting limits ($15,000 per individual for 2018) with the ability to make a lump-sum contribution equal to 5 years of gifting limits by making an election under IRS §529(c)(2)(B).
About 529 Plans
529 plans have now become quite flexible with respect to changing beneficiaries and use an expanded definition of “family.” Other items to note about 529 plans include:
529 plans are not only for secondary education anymore with the expansion to allow for K-12 expenses
Starting in 2018, 529 plans can now be used to pay up to $10,000 per year, per child, in qualified expenses for K-12 private school.
Note: It now appears that 529 plan assets will be incorporated into financial aid formulas as the funds are now technically available for tuition use. Take caution when considering this option as the states need to update their own codes to correspond with federal updates.
529 plans may now be a better option than its predecessor, the Coverdell ESA
With tax-free earnings growth and tax-free withdrawals for qualified purchases, Coverdell ESAs operate very similar to a 529 savings plan. There are, however, a few key differences:
There is now a potential for a state tax deduction (for states other than Washington)
A total of 35 states and the District of Columbia offer a full or partial state income tax deduction for contributions to a 529 plan (however, most restrict the deduction to contributions made to the in-state plan only). California, Delaware, Hawaii, Kentucky, New Jersey, and North Carolina do not offer a state income tax deduction. In addition, Washington, Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, and Wyoming do not have a state income tax so no state tax deduction is available.
Freedom and flexibility to have multiple accounts
Even if you currently have a 529 account for college savings, it might make sense to open another account for K-12 savings. Most families take advantage of the age-based investment options offered by 529 providers. With an age-based portfolio, the asset allocation will automatically adjust over time. Typically, the plan’s investments will start out more aggressive and switch to more conservative fixed income options as the beneficiary gets closer to college. Parents with a shorter time horizon, like elementary or high school, will want to use a different strategy.
Planning tip: If you qualify for a state tax deduction (i.e. other than a Washington state tax resident), you may want to contribute the annual maximum deductible amount into your home state’s plan to pay for K-12, and then look for an out-of-state plan with diverse investment options to save for college.
Effective pre-tax funding for college education is one of the most important tax planning ideas for parents, grandparents, aunts, and uncles. Start early and reap the rewards of having Uncle Sam help subsidize the cost of this very large and worthwhile financial commitment.
Contact Leslie Hurt or your Clark Nuber tax advisor for more information about 529 plans.
Leslie Hurt is a manager in the Tax Services Group, specializing in high net worth individuals.
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