The New Tax Code's Implications For 529 Plans
President Donald Trump signed An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018 on Friday, December 22, 2017. While the Act has effects on a wide range of tax situations, for this article we shall examine the effects the Act will have on the tax-advantaged savings plan known as the 529 plan.
The United States Securities and Exchange Commission defines 529 Plans as follows:
"A 529 plan is a tax-advantaged savings plan designed to encourage saving for future college costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code."
The IRS offers a detailed explanation of 529 plans. The following video answers the question "What is a 529 plan?"
What the recently enacted changes to the tax code did to 529 plans is to add K-12 private schools. 529 plans now permit you to save for both college educations and K-12 private school educations.
Now, just as is the case with private schools, perception often clouds reality. The popular press frequently refers to private schools as elitist and for rich kids. The same stigma will undoubtedly be leveled at the expansion of 529 plans to include K-12 private schools. But when you actually examine 529 plans as a whole and more specifically the 529 plan which operates in your state, you will discover as I did that you can save any amount of money, no matter how small. While maximums for the individual plans are set forth by each state, the contributions are modest. Zero to $25 minimum contributions are the norm. What I like about that is that a family of modest means can make small but regular contributions over the course of several years.
Depending on the investments which you select, your initial contributions will grow, thanks to compounding and savvy investment management. Several investment managers such as Fidelity and Vanguard offer 529 plans.
CalcXML has a calculator which illustrates how a 529 plan might grow your investment versus a taxable savings account. My assumptions in this example were an initial investment of $10,000 and an annual investment of $1,000. How much you decide to save for your child's private school expenses is a decision which you should make after discussion with your financial adviser.
Take time to review how a 529 plan managed by an investment manager can help you save for private K-12 education expenses such as tuition, books, room and board, and so on.
529 plans are state-operated.
It is important to understand that 529 plans are operated by individual states, as opposed to the federal government. Contributions to these plans are deductible from the appropriate state taxes, not your federal taxes. You can find a list of states which have set up 529 plans here.
There are four basic types of 529 plans.
- Broker Sold Savings Programs
- Direct Sold Savings Programs
- Prepaid Contract
- Prepaid Unit/Guaranteed Savings
Broker Sold Savings Programs are 529 plans which are sold by investment brokers, financial advisors, banks, and so on.
Direct Sold Savings Programs are 529 plans which are sold with no middleman directly by the state.
A Prepaid Contract allows you to prepay your child's future education at today's prices. Note: the number of states offering Prepaid Contract 529 plans is dropping. As Kathryn Flynn explains in SavingFor College.com:
"Most of what we hear and read about 529 plans is focused on the more popular "savings" plans, but for some families, there's another effective way to prepare for college costs. As the name implies, prepaid tuition plans allow you to pre-pay future college costs today. There are currently 18 state-sponsored and one institution-sponsored prepaid plan (Private College 529 Plan), but only 11 are currently accepting new applicants, and nine of these have residency requirements.
Of the 11 available plans, nine are "contract" plans, which allow you to pay for a certain number of semesters of college tuition, and two are "unit" plans, which let you buy fractional units that are redeemable in the future based on average tuition rates at a target group of schools, typically one percent of one year of tuition. In other words, contract plans work like a futures contract and unit plans operate like a tuition index fund."
If you have children in private school or plan to have children in private school, be sure to investigate 529 plans thoroughly. Ask your financial advisor for advice and guidance about the implications of the recently passed changes to the tax code and how they affect 529 plans.
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