Private, religious, and even public schools come with their costs. To make matters worse, most tax-free savings plans used to only be for higher education expenses. Now, savings plans are not just for college. Thanks to the 2017 Tax Cuts and Jobs Act, Qualified Tuition Programs (529 plans) now cover K-12 expenses. Nonetheless, there are some important caveats to be aware of, especially when it comes to how California conforms to the federal tax changes. Read on to see how you could save big on taxes by starting to save for your child’s education from a young age.
The 529 college savings plan is one of the most popular methods of saving for higher education expenses. With the passage of the 2017 Tax Cuts and Jobs Act (TCJA), the tax benefits of the 529 plan have been expanded even further. Even if your child is not of college age yet, read on – we have exciting news for you, too!
What is a 529 Plan?
Qualified Tuition Plans (also known as QTPs or 529 plans) are a popular way for parents and other family members to save for a child’s education. They are programs under which an individual may prepay tuition credits or make cash contributions to an account on behalf of a beneficiary for payment of qualified education expenses.
A 529 plan must meet a handful of requirements. Such requirements include that all transactions must be made in cash, a separate accounting must be made for each designated beneficiary, and adequate safeguards must be made to prevent contributions in excess of those necessary for the educational expenses of the designated beneficiary.
While contributions to 529 plans are not deductible, there is no income limit for contributors, and earnings on contributions are not taxable. Distributions are also free from federal tax as long as they are used to pay for qualified education expenses for a designated beneficiary. Qualified expenses include tuition, required fees, books, supplies (including computers and any peripheral equipment/software), as well as room & board for any student enrolled more than half time in a higher education program.
It is important to note that when making contributions to a 529 plan, any contributions totaling more than $15,000 from one individual (including any other gifts made by said individual) could result in gift tax consequences. However, there is an exception which allows a contributor to front-load the plan for up to five years in one sum with no gift tax consequence. If this election is made, up to $75,000 (5 x $15,000) can be contributed to a 529 plan in one lump sum without triggering any gift tax consequences. Once the five years have lapsed, the donor is then free to contribute again if they wish.
What Has Changed with the New Tax Law?
Before the recent changes, all of the above information only applied to college expenses, i.e. college. Nonetheless, with the passing of the Tax Cuts and Jobs Act comes a handful of changes to 529 plans. Now, for any distribution from a 529 plan made after December 31, 2017, qualified education expense also includes tuition in connection with the designated beneficiary’s enrollment or attendance at any K-12 school, whether public, private, or religious.
While there are no limits to college distributions as long as they do not exceed any qualified expenses, distributions for elementary or secondary tuition are limited to no more than $10,000 incurred during the tax year in connection with the enrollment or attendance of the designated beneficiary.
529 ABLE Plans
With the TCJA comes changes to 529 ABLE plans as well. A 529 ABLE (Achieve a Better Life Experience) plan allows a disabled beneficiary or their family to save in a tax-deferred account. The structure and limitations for these accounts are very similar to regular 529 plans, but are made to meet qualified disability expenses of the designated beneficiary in lieu of education expenses.
The new provision allows for amounts from regular 529 plans to be rolled over to an ABLE account by 2026 without penalty, provided that the ABLE account is owned by the designated beneficiary of that 529 account or a member of such designated beneficiary’s family. Such rolled-over amounts count toward the overall limitation on amounts that can be contributed to an ABLE account within a taxable year. Any amount rolled over that is in excess of this limitation is includible in the gross income of the beneficiary.
What About California?
As with all changes that come with the Tax Cuts and Jobs Act, there is a question of whether or not California will conform to the federal changes. In this case, California has made it clear that they will not conform to 529 account funding for elementary and secondary education or to the new federal rules relating to the maximum distribution amount. This means that for California purposes, 529 plans are still only for higher education expenses.
For California taxpayers, the earnings portion of any distribution from a 529 plan to pay for tuition expenses at a public, private, or religious K-12 school or any amount rolled over from a QTP to an ABLE account may be subject to California income tax as well as an additional 2.5% penalty.
It can be overwhelming to understand the tax implications of an education savings plan. If you have any questions regarding these plans or any other tax matters, please do not hesitate to contact your L&B professional at (858) 558 – 9200.