In 1996, the Small Business Job Protection Act created 529 savings plans: state-administered programs designed to help parents save for their children's future college costs. In a 529 plan, deposited funds are allowed to grow free of federal and state taxes and growth remains tax-free as long as the money is used for qualified educational expenses. There are no eligibility limits on age or income, and many states offer deductions or tax credits on 529 plan contributions.
These perks make 529 plans extremely popular vehicles for college savings – and thanks to a provision in the recently passed Tax Cuts and Jobs Act, 529 plan funds may be applied on up to $10,000 per year of kindergarten through 12th grade educational expenses as well.
Should you take the opportunity to fund primary education with a 529 plan? Perhaps, but experts urge caution for several different reasons.
First, it's important to check with your state's plan. Some states follow the federal code for defining a qualified expense, while other states strictly define the plan as valid only for college expenses. State legislatures may need to pass laws to meet the federal standard or clarify differences – and state lawmakers may not wish to change their laws. They arguably have incentive to move 529 definitions away from the new federal standard thanks to the potential loss of tax revenue.
Parents could simply funnel private school contributions through a 529 program, avoiding state taxes and depriving state coffers of funds that have already been included in this year's budget. Nat Malkus, the American Enterprise Institute's Deputy Director of Education Policy Studies, projects that New York could lose up to $200 million in tax revenue, Indiana could lose almost $150 million, and Illinois could take a $90 million tax hit.
If your state does not choose to meet federal standards, you could lose out in several ways with K-12 spending. You could have to pay state income taxes on the gains that are withdrawn for K-12 expenses, and you could face repayment of previous deductions/credits. States may also choose to impose penalties if K-12 expenses are not considered as qualified expenses under the state definition.
There's another downside to using 529 for K-12 funding. By constantly depositing and withdrawing the funds early, you never allow the full tax-free growth that 529 funds were designed to provide. It makes a 529 more of a tax-avoidance plan than an educational-savings plan.
The entire strategy of 529 funds changes with a shift to K-12 education, according to Eric Bronnenkant, CPA, Certified Financial Planner®, and Head of Tax at Betterment. "Let's say your grammar school is coming up soon," Bronnenkant poses. "You want to keep that money as more of a short-term investment and be more conservative, whereas college may be 10 or 15 years down the road and you'd essentially want to be more aggressive with those funds."
You may benefit significantly from using a 529 plan for K-12 expenses, but it's not the obvious choice for everyone. You must balance tax savings on private school tuition with potential higher growth and/or tax savings down the road, as well as your child's options for other collegiate funding sources (scholarships, internships/part-time jobs, or student loans).
Find out what your state 529 plan will allow, and if the situation is murky, you may want to wait for a year before making any withdrawals – but don't wait to establish a 529 plan or contribute to an existing one. The benefits are undeniable, whether you take advantage of them now or later.
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