Over the last 20 years, many people have used 529 plans as a way to save for their children's or grandchildren's college education on a tax advantaged basis. Basically, if you put money into a 529 plan and invest it, you can reap the benefit of the growth on the money in the plan tax-free if it is used to pay for qualified higher education expenses for the beneficiary of the 529 account. Those expenses typically include college tuition, room and board, books, computers, software, and other items.
Now, a new provision in The Tax Cuts and Jobs Act expands the benefits of 529 plans. The new provision allows for tax free withdrawals from 529 plans for the payment of up to $10,000 per year per student of K-12 private school tuition, giving parents and grandparents more options on figuring out how to best fund and pay for the education of their children and grandchildren.
One of the primary benefits 529 plans have for paying for qualified higher education expenses in college is that if money is invested early into the 529 plan, it may have over 15 years to grow tax free while the child is completing their K-12 education. With that longer time frame, the best investment strategy would likely be one which is mostly invested in stocks or stock funds. If you are planning on using funds from a 529 plan to pay for K-12 private school tuition, the time frame for growth and compounding inside the plan is much shorter than if funding for college, so the portfolio investment mix should be more conservative, tilting more heavily to bonds, bond funds or other more conservative investments.
One strategy to consider in order to maximize the tax benefits that 529 plans offer, whether you are planning on funding college expenses, K-12 tuition, or both, is to front-load the contribution to the plan. In 2018, a single person is allowed to gift up to $15,000 per year per person estate and gift tax free, for married couples, that is $30,000. Then, there is a special provision for funding 529 plans that lets you contribute five years of gifts up front into the 529 plan, then complete and file the appropriate federal tax forms in order to utilize the current year's and following four years' gift tax exemptions. This would allow a single person to gift and fund a 529 plan per beneficiary up to $75,000 in year one, and married couples to gift and fund a 529 plan per beneficiary up to $150,000 in year one, all federal gift and estate tax free. Because these are considered gifts, once contributed to the 529 plan, these funds are considered outside the donor's estate and may have the effect of reducing estate taxes, too.
A final note, because the new tax bill is so new, many states need to update their tax code before withdrawals from 529 plans to pay for K-12 private school tuition will be state income tax free. Eighteen states and the District of Columbia have rolling conformity with the federal tax law, while nineteen states (including Georgia) have static conformity and need to adopt conforming laws each year. The other states either have their own tax calculation starting points or their own formulas. Before taking money out of your child's or grandchild's 529 plan to pay for K-12 private school tuition, please make sure that you understand the state income tax consequences of your withdrawal.
The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that a college-funding goal will be met. In order to be federally tax-free, earnings must be used to pay for qualified education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient's marginal rate and subject to a 10-percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses