What You Need to Know
- Clients seeking tax-friendly ways to fund private school costs might find this option attractive.
- Use of these plans for K-12 school costs is more limited than for college costs, and it may affect aid eligibility.
- Be sure to carefully examine the laws of the state where the client wishes to open a 529 plan before taking action.
It’s back-to-school time again, meaning that many clients are turning an eye toward tax-smart saving strategies to pay for the ever-increasing cost of education. Most of those clients are already familiar with Section 529 college savings accounts.
However, those clients may have overlooked a provision of the 2017 tax overhaul that allows 529 plans to be used for primary and secondary education costs. Clients who are interested in exploring tax-friendly ways to fund private elementary and high school costs might find the Section 529 plan option attractive — but should, as always, read the fine print before deciding if this savings option is best for them.
Using 529 Plans for Private School Costs: The Basics
IRC Section 529 education savings plans are funded with after-tax dollars that are permitted to grow on a tax-free basis and function much like a Roth IRA. In other words, distributions from the account are not taxed when received so long as they are used to pay qualifying higher education expenses (any gains on the account value are also received tax-free).
Under current law, Section 529 plan funds can now be used to cover the cost of primary and secondary school tuition. Under prior law, 529 plans were postsecondary (college and university) funding mechanisms alone. Up to $10,000 per year can now be withdrawn from these accounts to cover elementary or secondary school tuition (the $10,000 limit applies on a per-student basis).
Clients should note that while 529 plan funds can be withdrawn tax-free to pay private elementary and high school costs, tuition is the only qualifying expense. Books, fees, computers and other ancillary expenses associated with elementary and high school education cannot be funded with 529 plan funds on a tax-preferred basis (note, however, that these are qualifying expenses at the college level).
Clients can contribute up to $15,000 (the annual gift tax limit) to the 529 plan — or have the option of contributing five years’ worth of contributions at a single time (in a lump sum of up to $75,000). Married couples can double these amounts.
Considerations Before Funding the 529 Plan
At least 30 states offer deductions or credits for 529 plan funds at the state level. But every state is different, so it’s important to carefully examine the laws of the state where the client wishes to open a 529 plan before jumping into anything. It’s possible that the state does not follow federal rules in this area (meaning that the funds could be taxable at the state level even when withdrawn for qualifying K-12 tuition).