Broker Check

Help Clients Understand New Flexibility in 529 Plans

| March 23, 2018

Tax season is an opportune time for financial advisors to review client financial situations and examine whether new strategies might be in order. The changes affecting the federal tax code that were signed into law in late 2017 under the Tax Cuts and Jobs Act make that review even more critical this year. One change that is worthy of examination is an update affecting college savings accounts which could provide financial flexibility for clients who meet the criteria.

Essentially, assets in the Qualified Tuition Program now have more options that qualify for use. These are the so-called 529 accounts, named for the section of the tax code that describes them, created in the mid-1990s to provide tax incentives for college savings. But revisions in tax law now permit 529 accounts to pay up to $10,000 a year for expenses to include tuition at elementary or secondary public, private, or religious schools. A summary of the changes is available at the Internal Revenue Service (IRS) web site HTTPS://WWW.IRS.GOV/NEWSROOM/529-PLANS-QUESTIONS-AND-ANSWERS

Earnings in 529 accounts are not subject to federal tax and generally are not subject to state tax when used for the qualified education expenses, such as tuition, fees, books, or room and board at an eligible education institution. Computers and software were recently added as qualified expenses.

An article posted at INVESTMENT NEWS speculated that the changes could inspire additional contributions to 529 accounts, as they are now more competitive with Coverdell Education Savings Accounts (which have much smaller contribution limits). “So, clients who previously may not have been saving money in a 529 plan, perhaps because they didn’t have extra money to save for education beyond the tuition for a child’s private elementary school, can consider contributing to a 529 and, shortly thereafter, taking a 529 distribution to pay K-12 tuition.”

529 ABLE Accounts

Another change provided under the Tax Cuts and Jobs Act allows up to $15,000 in annual transfers from 529 accounts to 529 ABLE accounts, which are designed for people who become disabled or blind before age 26. Withdrawals from 529 ABLE accounts can be tax-free when used for expenses like housing, employment training or legal fees. Clients interested in this approach are advised to confirm that this activity is allowed in their state before moving forward with such transactions.

Caveats and Cautions

Financial advisors should help their clients understand that just because the federal tax law has changed, state tax law may not have. States that do not automatically follow federal law on 529s may have to update their own tax code before account-holders can take advantage of all the new benefits. Until they do, those states that do not currently have laws permitting the use of funds for K-12 expenses or allow funds to be transferred to an ABLE account may consider use of 529 money for these expenses as a non-qualified distribution and charge penalties. Such clients may be asked to pay back a state tax deduction they’ve already received or pay state tax on investment gains.

Even in cases where states permit expanded use of 529 funds, clients should be advised about a potential drawback. Private schools will probably consider 529 savings when making financial aid decisions for the school year. Financial advisors can help clients decide the best course of action in those cases.

The best practice is to contact the entity that administers a client’s 529 account before they proceed to use the funds under the expanded federal provisions.