The Tax Cuts and Jobs Act (TCJA) enacted in late 2017 expanded the usefulness of 529 plans for some families. Prior to TCJA, 529 plans could be used only for qualified HIGHER education expenses (i.e., post-high school), but the new law allows 529 plan funds — up to $10,000 per year per student — to be used for qualified K-12 tuition.
Who can take advantage of this provision, and how should they go about it? If you already have funds in a 529 plan and you incur K-12 tuition expenses, you can withdraw from your 529 plan up to the amount of the tuition expenditure but not to exceed $10,000. As with any 529 plan withdrawal, the disbursement must occur in the same year as the qualified expense. However, keep in mind that using a 529 plan for K-12 tuition will deplete funding for college unless you make additional contributions.
Some taxpayers can take greater advantage of the new law by funneling current-year K-12 tuition payments through a 529 plan, then immediately withdrawing them to pay the tuition bill. However, this only benefits taxpayers in the 35 states and Washington, D.C., that offer an income tax deduction, credit or matching contribution for 529 plan deposits (click here for a list of states offering such benefits). For those taxpayers, passing K-12 tuition payments through a 529 account effectively reduces the cost of tuition by the value of the tax break or match.
There are three more caveats to using 529 plans for K-12 tuition. First, a number of states are warning residents that this strategy might be disallowed in the absence of changes to state legislation, so it’s best to consult with your specific plan and tax advisor to confirm the feasibility of this strategy.
Second, due to the recent nature of this change, it is not clear if or how 529 plan distributions during high school might impact eligibility for college financial aid. A 529 plan withdrawal during sophomore year of high school could adversely affect the financial aid award for a student’s freshman year of college.
Third, some states and certain investment options impose a holding period during which withdrawals cannot be made, and those rules are always subject to change. Furthermore, many plans that do not impose holding periods stipulate that new contributions might take a week or more to “settle.” If you are considering this strategy, please consult the specific plan to be sure it permits withdrawals shortly after contributions or within your timeframe.
If you think this strategy would be beneficial for your family, it might be wise to open a 529 account for K-12 tuition separate from your college 529 account because the investment strategy for a distant college expense might be inappropriate for a current or imminent K-12 expense. If you are considering changing the allocation of an existing 529 account, be aware that 529 plan rules permit only two investment option changes per year.
Finally, TCJA allows existing 529 college savings plan balances to be rolled into 529 ABLE accounts. ABLE accounts are designed to help people with qualifying disabilities to save for education and living expenses. The rollover is permitted between accounts with the same beneficiary or to the account of a family member of the original account beneficiary. The benefit of this change is as follows: Some families save for college only to discover that their child has a disability or develops one. The new provision allows those families to use their 529 funds for non-education expenses without being penalized or taxed on the distributions. Currently, 30 states offer ABLE plans with more in various stages of development. The ABLE National Resource Center is a good source of information on 529 ABLE accounts.