If you have (or want) children, you may already know about 529 savings plans, but did you know 529 qualified expenses now include private school education costs?
As of January 2018, private school tuition now falls under the 529 plan’s umbrella of qualified education expenses. Savings from a 529 account can be tapped to fund education-related expenses as early as a child’s kindergarten year, and continue to be used throughout the entirety of their primary, secondary, high school, college, and graduate school years.
While our firm remains a heavy proponent of using 529 plans to pay for college tuition, we have expanded our focus to include using a 529 savings plan to assist with private school education costs. In this article, we will walk through the advantages of using a 529 plan to save for a child’s private school K-12 education, as well as the limits, restrictions, and discrepancies you should consider when determining your long-term savings strategy.
What to Consider When Using a 529 Plan for Private School Education (K-12) Expenses
A 529 savings plan works much like a Roth IRA and the new rules under the 2018 Tax Cuts & Jobs Act allow for greater flexibility when using a 529 savings plan. However, the changes may impact the way parents and grandparents incorporate the savings vehicle into their long-term financial plan. Now that the time between a 529’s initial funding and the date the assets are available for use has been shortened, families may need to reconsider how their current investment strategy will support their education savings goals.
Private school tuition has skyrocketed and is only predicted to increase over the next eighteen years. Today, the total cost of private school education (K-12) for a child entering kindergarten is approximately $182,868.
If a child is born today (2018), the total cost for their private school education will be approximately $239,001 once they are old enough to attend kindergarten. This is assuming an education inflation rate of 5.5% and that the child will enter kindergarten at age five.
That’s a $56,133 increase after only five years!
We recommend estimating the cost of sending your child/grandchild to a private institution for their primary, secondary, and high school years. Savingforcollege.com has a helpful online 529 Savings Calculator for Private K-12 Tuition you can use to estimate the costs associated with your unique situation, as well as how much you need to save in a 529 to be able to cover these costs. Please note that these are merely estimates and you should talk with your financial advisor to ensure your savings strategy aligns with your long-term financial plan before you take action.
Whether a 529 is used to fund college or private school tuition, the tax-free growth remains its most notable advantage. With that in mind, a number of families with young children may not have the means to simultaneously max out their retirement plan, cover living expenses, AND contribute to a child’s 529 savings account. This is where grandparents may be able to ease the future burden of education costs for their children and grandchildren.
Understanding the 5-Year Election Limits of a 529 Plan for Private School Education (K-12) Expenses
The flexibility inherent to a 529 savings plan provides a valuable opportunity for grandparents to supplement their children’s future cash flow by gifting education savings to a 529 account for their grandchildren, and doing so while the grandchildren are still very young. In addition, the account can be transferred between relatives so that if a 529 is overfunded, the family’s investment does not go to waste.
Consider that you are the grandparent of a newborn child today (2018). You and your spouse want to help fund your grandchild’s private school education by contributing the maximum amount of funds possible to a 529 without being subject to gift tax on the investment. The 529 Plan’s 5-year election rule allows you to do just that! Couples can contribute up to $150,000 ($75,000 for an individual) per child to a 529 savings account and still qualify for the annual gift tax exclusion on the contributed funds.
For example, if you gift the maximum tax-free contribution of $150K ($75K for individuals) to your grandchild’s 529 today in 2018, the investment will total $266,939 by the time they’re old enough to attend kindergarten. This is assuming the child starts kindergarten at age five and the 529 contribution compounds at a rate of 7%.
That’s $116,939 of growth in only five years!
By gifting to the 529 plan early on, you enable the compounded tax-free growth to be in full effect by the time your grandchild starts his/her private school education.
The tax-deductible contributions, tax-deferred compounding and flexibility to change the account beneficiary to another family member also position 529 accounts as a strategic estate-tax planning tool for grandparents. They can save for the future of their grandchild and shelter a large amount of assets from estate taxes, all while retaining control of the funds.
Limits to Using a 529 Plan for Private School Education (K-12) Expenses
One noteworthy difference between paying for private school and paying for college using a 529 is that while there is no cap on 529 withdrawals for qualified college expenses, a $10,000 cap exists for annual tax-free withdrawals from a 529 plan when funding private school expenses. You can still withdraw more than the $10,000 cap from a 529 account for private school costs, but you will pay taxes on any amount exceeding the limit for that tax year.
Some states have yet to conform to federal tax code. These states still allow families to fund pre-college private school education expenses, but the withdrawal may not share the same state-tax benefits as the over 30 U.S. states already offering a tax credit or deduction for contributing to a 529 plan. Review full list of states that consider k-12 tuition to be a qualified education expense under the 529 rules.
It’s important to note that parents and/or grandparents should generally avoid reducing their annual retirement plan contributions in order to contribute to a 529 savings plan. In most cases, we recommended maxing out your retirement savings accounts before contributing to a 529 plan. Why? Because you can still withdraw funds for education related expenses from after-tax accounts such as an IRA or Roth IRA penalty-free, even if you’re not 59 ½. In addition, a 529 plan should align with your long-term financial strategy and you should avoid pulling cash from these accounts just because you can.
Nevertheless, if you have the cash flow to allow it, taking advantage of the new 529 rules can be a valuable way to support a child’s educational development from day one.
You should always approach saving with a concrete strategy, which is why you should speak with a trusted financial advisor to determine how a 529 savings plan can help maximize your contribution to the future of your children and/or grandchildren.
To discuss 529 plans further, feel free to contact us to schedule a meeting, or to speak to one of our financial professionals.
