Hey everyone, it’s Finance Fridays again. I’ve been talking way too much about cryptocurrency lately, so today I wanted to do something different. Today we’re going to talk about 529s and the New Tax Law 2018.
Stock Photo from: Pixabay
New Year, New Taxes
So in the new year, I received a nice little notice from my 529 – Utah Educational Savings Plan (UESP) account. It talks about the implications of the new federal tax law and how it could potentially change how you use 529s a little.
Basically, what I want to talk about today is the new “Eligible K-12 Expenses”.
Eligible K-12 expenses
Beginning on January 1, 2018, UESP account owners may take tax-free withdrawals up to $10,000 annually from their accounts for tuition expenses at public, private, or religious schools. This provision will apply to elementary, middle, and high schools.
Payments for eligible K-12 expenses cannot exceed a combined total of $10,000 from all qualified tuition programs, including UESP.
(taken from the email)
So what does this mean?
Well, before I get too much into it, I’d recommend you read my previous posts on 529s first if you don’t really know what they are:
Ok, now I’ll assume you understand what a 529 is.
This new provision in the federal tax law for 2018 allows you to use up to $10,000 annually from your 529 to pay for tuition expenses at public, private, or religious schools, as stated above. However, you must note, this is only for elementary, middle, and high school. This does not include preschool or daycare.
If your child is in a public school system with free tuition then this doesn’t really change much for you. What you do with your 529 doesn’t really change.
However, if you plan for any of your children to go to a school which charges tuition then this may change what you do with your 529 slightly.
Example
Your child has just been born. You and your spouse want your child to go to private school from day 1 of kindergarten. Previously you had planned to put ~$200 a month away for your child into a 529. However, because of this new provision, you may want to reconsider and put in more than that.
Let’s assume the tuition for your child will be around $10000 a year at private school (just to make the math easier). Then, ideally you’ll want to try to build enough money into the 529 before that time so you can take advantage of your tax-free growth that occurred. Then you would pay the tuition from the 529, and replace the tuition you would have paid in tuition into the 529 + whatever your original goal was. In this particular instance let’s go with:
Instead of $200 a month, you go with $400 a month starting with your child’s birth. Let’s make a conservative estimate of 5% interest:
So if we use the handy compound interest calculator, just input 1, $400, 5, and 5% and you’ll have $26,524.31.
Contrast this to $200, which is 1, $200, 5, and 5% and you get $13,262.79.
As you would expect, it’s basically double since we doubled how much you put in monthly.
So now what?
Since you put in extra, you can now take out $10000 from your 529, using that tax-free growth to use toward your child’s private school tuition. This would drop your 529 down to $16,524.31. However, if you continue to pay into the 529 and replace the $10000 you used + normal contribution +/- a little extra, then you will efficiently utilize that tax-free growth from the 529. This will likely also help you save more money in your 529 overall.
Basically, you pay into the 529 and the 529 pays (some or all) of the tuition.
Wait, couldn’t I lose money?
Yes, the 529 still relies on how the stock market is doing and no one can predict the stock market.
However, over the long term, I still think the benefits of utilizing the 529 to pay for tuition are greater than the risks.
What if I overfund my 529?
I think this is unlikely considering how college tuition continues to rise.
However, in that instance, your child could put the 529 toward graduate school, or additional schooling, or transfer it to someone else in the family (not just immediate family), or to their children (your grand children). You could also withdraw it at a 10% penalty — although I would advise against this.
What about you?
Well, I already told you guys that I chose to live in a place with good public schools. However, I think my children will eventually go to private school for middle and high school. I’ve been putting money toward 529s for the last few years. I have been meaning to accelerate it in the coming years since a few extra expenses that I had will be gone , such as child care and a car payment. I am planning to move all the money saved into their 529s and into paying off our student loans.
However, now with this new federal tax provision, I may increase the amount I put toward their 529s to more than I previously stated. I will probably increase my planned (already increased) contribution another 20% on top of that. I think this will provide a reasonable cushion from which to withdrawal their tuition when it comes time for middle and high school.
My daughter is only 4, and starts kindergarten next year. She won’t be going to private school until at least 6th grade, so I have a few years to tinker with it to see where it will be. How much I save may go up or down slightly, but I plan to take advantage of using $10000 to pay part of her tuition. Then when son starts, I would do $5000 from his 529 and $5000 from hers to total the $10000. In this way, I hope to keep their 529s reasonably close to each other in terms of savings.
Wait, can I do this for each of my kids?
Unfortunately, no.
It’s $10000 total withdrawal from your 529 a year. However, you could potentially split the $10000 for your two children if their tuition is less than $10000/year.
For example, if their school tuition was $8000/year, you could pull out $10000 and pay for one child’s full tuition with the 529 money and then use the leftover $2000 to pay for part of the other child’s tuition.
Can I just dump a lot of money into my 529 a head of time?
Yes.
If you have a lot of money saved, then you can dump up to $140,000 into a 529 when your child is born. The 529 plan supports a unique feature which allows you to pre-fund up to five years of contributions gift tax-free. This is called ‘”superfunding”. Each parents can “pre-fund” a child’s 529 for 5 years with limit of $14,000/yr.
So, each parents “funds” $14,000 x 5 years x 2 parents = $140,000.
The money would grow tax-free until your child starts private school at which point you would pull out $10000 a year from the 529 to cover part (or all) of the tuition. Then, when your child goes to college, whatever is left in the 529 (spoilers: it’s a lot) can be used for college.
TL;DR
New tax year, new 529 stuff.
You can withdraw up to $10,000 a year (total) from your 529s to use toward tuition for K-12.
You may want to consider putting more money into your 529 contribution if you plan for private school K-12. (I plan to)
The idea of “superfunding” a 529 is also now a lot more desirable.
-Sensei
Agree? Disagree? Questions, Comments and Suggestions are welcome.
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