A few weeks into the new year, many clients may have already given up on some of the more traditional New Year’s resolutions, making this a good time of the year to shift focus toward financial goals for 2019. Education savings is an important objective for most clients with children because of the ever-increasing cost of college tuition.
Post-tax reform, however, tax-preferred education savings possibilities abound even when college funding needs have yet to register on the client’s radar. While saving for college remains a central goal for many, it is now important to remember that tax reform has expanded the universe of possibilities for tax-preferred Section 529 savings even for those clients with young children who have a more immediate need for education funding.
Section 529 Education Savings Accounts
IRC Section 529 college savings plans are funded with after-tax dollars that are permitted to grow on a tax-free basis (much like a Roth IRA), so that distributions from the account are not taxed when received so long as they are used to pay for qualified higher education expenses.
Contributions to a Section 529 plan are limited to the annual gift tax exclusion amount—meaning that clients can contribute up to $15,000 per year in 2019. If contributions exceed that amount with respect to any single individual’s account, the contribution will be considered a gift that will generate gift tax liability. Clients also have the option of bundling their contributions for up to five years in a single year—making a $75,000 contribution in one year rather than over a five-year period.
Clients are permitted to fund multiple Section 529 plans for different beneficiaries without gift tax consequences, as long as the annual contribution for any particular beneficiary does not exceed the annual exclusion amount. The client is also permitted to change the original account beneficiary—for example, if one child chooses not to attend college.
Clients should pay attention to the fine print of the particular 529 plan that they choose to invest in, as some plans will allow the account owner to make investment choices, and others automatically choose how the funds are invested.
Post-Reform Expansion of Section 529 Savings Options
Under prior law, qualified education expenses for Section 529 plan purposes were generally limited to cost incurred to pay for post-secondary school (i.e., college or university). However, the 2017 tax reform legislation expanded the reach of Section 529 plans so that clients may now use up to $10,000 in 529 plan funds per year for elementary or secondary school expenses (although it remains important to check with the plan itself to confirm that they have modified their rules to implement this new federal rule).
The new $10,000 limit for elementary and secondary school expenses applies on a per-child basis, so that even if the child is beneficiary of multiple Section 529 plans, he or she may receive only a total of $10,000 in pre-tax distributions annually for pre-college educational expenses.
Tax reform also modified the Section 529 plan rules to permit a tax-free rollover of 529 plan funds to an ABLE account with the same beneficiary, or a beneficiary who is a family member. ABLE accounts are similar to Section 529 plans, but are designed to provide tax-free distributions to cover expenses of individuals suffering from various disabilities. Funds that are rolled over count against the $15,000 annual contribution limit for ABLE accounts.
Tax reform has significantly expanded the possible uses for Section 529 funds, meaning that more clients may now be interested in contributing to these tax-preferred accounts than was the case under prior law. As always, however, it is important that clients read the fine print on the particular 529 plan to make sure they are maximizing the available options.
- Read previous coverage of planning for education savings in Advisor’s Journal.
- For in-depth analysis of the rules governing Section 529 plans, see Advisor’s Main Library.
- Your questions and comments are always welcome. Please post them at our blog, AdvisorFYI, or call the Panel of Experts.