One of the top strategies to plan and invest for education expenses is the use of a 529 Plan. Taxpayers can contribute funds to a 529 plan every year for themselves, their kids, or anyone else they choose. The earnings on the contributed funds are tax free so long as they are used for qualified education expenses. In addition, 36 states currently offer a state tax credit or deduction for contributing to a 529 plan up to a certain limit. For example, Massachusetts’ 529 Plan is administered through Fidelity and offers a $1,000 ($2,000 for married filers) deduction for contributions to the plan. For more details on the MA plan see the following link – https://www.fidelity.com/go/529-Massachusetts/ufund-faqs.
The Tax Cuts and Jobs Act of 2017 made significant changes to the rules and limits related to 529 plans. These new rules are effective as of January 1, 2018. Under previous law, any earnings and distributions from 529 plans were not taxable for federal tax purposes as long as distributions were used to cover college education expenses including tuition, fees & books as well as limited room and board costs.
Under the new law, the definition of qualified education expenses has been expanded to include elementary and secondary private, public & religious schools’ tuition. The new rules place a $10,000 per year, per child limit on withdrawals to cover elementary & secondary school tuition. The $10,000 cap does not apply to post-secondary expenses.
Prior to the new tax law, the only tax-free opportunity to save for elementary and secondary schools’ expenses was a Coverdell Education Savings Account. Coverdell accounts operate similar to 529 Plans except that they impose a $2,000 per year contribution limit. 529 plans do not have a contribution limit but there is a limit on the amount of funds that can be held in an account. For 2019, the account limit in MA is $400,000 per beneficiary.
The current changes only apply to Federal tax law. We will have to wait and see whether Massachusetts and other states conform to the same rules. The problem is that 17 states haven’t updated their tax codes to be in line with the new Federal laws. For many individuals in these states there may be a surprise tax bill on the state level. These 17 states include Arizona, California, Colorado, Connecticut, Hawaii, Illinois, Maine, Michigan, Minnesota, Montana, Nebraska, New Jersey, New Mexico, New York, Oregon, Vermont, Wyoming. If you were to use your 529 plan in one of these states, you would face taxes and penalties on the amount withdrawn.
Taxpayers planning to incur educational expenses for K-12 tuition now have a new planning opportunity to minimize taxes from these expenses. Here at Newburg & Company we can help you plan for this tax change and the many other changes resulting from tax reform.