The new tax bill that became effective this month has broadened the use of 529 college savings plans. The plans, named after the 1996 tax code that created them, offer families a method of saving for qualified college expenses with after-tax dollars that grow tax-free. They’re like a Roth account that can be used for college.
So what’s the change? Prior to 2018, qualified expenses—which include tuition, room and board, required technology, books, and supplies—applied only to colleges and universities. This year, they have been extended to include K-12 expenses for up to $10,000 per year.
While this may sound like a significant benefit, for most people it won’t amount to nearly as much as the help with college savings. That’s because when saving for college, parents can tap into years—even decades—of tax-deferred compounding growth before they tap the money. The longer the savings horizon, the greater the benefit. If you withdraw the money in the next couple of years to pay for private middle-school tuition, you won’t gain much of an advantage.
The change will have a huge impact for the minority of families able to fund a 529 plan when the beneficiary is still very young. If an account is front-loaded with contributions, the time horizon for growth might be long enough to justify tapping it for middle school and high school expenses—assuming it will still contain enough to carry the child through college, too.
Another factor to consider when deciding whether to take advantage of the K-12 provision is state income tax rules. On the federal level, you can’t get a tax credit or deduction for contributing to a 529 account. But in 33 states, you can. And you don’t have to stick with your own state’s plan—most plans allow non-residents to participate.
When it comes to tax benefits, the states are far from uniform. Surprisingly, California, the largest state in the union, offers no state income tax benefit for contributing to its 529 plan, the Scholar Share 529. New York, on the other hand, offers a $5,000 deduction ($10,000 if you’re married and filing jointly) for contributing to its NY 529 Direct Plan.
One important caveat: most states have not yet amended their plans to account for the addition of K-12 expenses, and it’s possible that they could decide to exclude them.
As you can imagine, there are many variables that come into play when choosing a 529 plan. We advise you to lean on your financial planner for help with your education funding projections.
To educate yourself more on the new complexities of 529 plans, please see NPR’s Congress Changed 529 College Savings Plans, And Now States Are Nervous. For a comparison of state plans, we recommend visiting Savingforcollege.com.