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Two significant pieces of legislation were recently passed that affect education savings plans and strategies for Americans: the Tax Cuts and Jobs Act (TCJA) of 2017 and the Setting Every Community Up for Retirement (SECURE) Act, signed into law on December 20, 2019. The TCJA provides tax benefits to lower- and middle-income families and the SECURE Act encourages better savings habits and helps Americans achieve financial security. While provisions about 529 plans within these laws are not lengthy, the implications and benefits are far-reaching, both for families saving for college and graduates with outstanding student loans to repay.
Benefits of 529 plans
As one of the most popular education savings vehicles, 529 plans offer flexibility and potential tax advantages that don’t exist with other college saving mechanisms. Contributions to 529 plans are made with after-tax dollars and grow tax-free if withdrawals are used for qualified education expenses. While there is no federal tax deduction for 529 plan contributions, 37 states and the District of Columbia offer state-level deductions or credits as a savings incentive.
Another benefit is that 529 plans are low maintenance, with many companies offering “set it and forget it” investment options and the flexibility of transferring unused funds to another beneficiary. This means extra cash can easily be reallocated to another family member to help pay for college expenses.
Changes to 529 plans
529 plans were originally created to help families pay for costs associated with post-secondary education for a named beneficiary. One of the most common concerns parents have about opening a 529 plan, however, is having leftover funds after the beneficiary has graduated from college. Thanks to the TCJA, 529 plans can now be used to pay for up to $10,000 of annual tuition expenses to attend public, private or religious elementary or secondary schools. This annual allowance is per student, not per account. If a student is the beneficiary of multiple plans, distributions are limited to a total of $10,000 a year, and excess distributions are included in gross income.
Additionally, the SECURE Act expanded the definition of qualified higher education expenses to include student loan payments and apprenticeship programs, leaving more options for families to use these savings tax-free. These new 529 rules are retroactive for distributions made after December 31, 2018.
Student loan repayments
Student loan debt is one of the largest classes of consumer debt, affecting over 45 million Americans. According to a report from Forbes, student loan debt reached almost $1.5 trillion in early 2019, with the average student loan burden of approximately $30,000 for college graduates.
With the SECURE Act, 529 plan holders can now withdraw any remaining savings to put toward their own student loan debt, or that of their children, grandchildren, or spouses. The law includes an aggregate lifetime limit of $10,000 in qualified student loan repayments per 529 plan beneficiary and $10,000 for each of the beneficiary's siblings. Siblings may include a brother, sister, stepbrother or stepsister. This means a family with two children can take out a maximum of $20,000 to pay down student loans.
According to the College Savings Plans Network, there are approximately 14 million open 529 accounts holding an average of $25,000 each. The new loan payment option could help families with excess balances. For instance, if a younger sibling does not need the full balance in the 529 account, the family could use leftover money to help pay down student-loan debt of the older sibling. Alternatively, a parent, as the owner of a 529 account, could name themselves as the new beneficiary and take a $10,000 distribution to repay their own federal or private parent loans.
Even though up to $10,000 of principal and interest payments toward a qualified education loan are now considered qualified education expenses, taxpayers need to be cautious of the “double dipping” provision. If you use a 529 plan distribution to repay student loan interest tax-free, you cannot claim the student loan interest deduction for those same repayments when you file your income tax return. The student loan interest deduction phases out at certain income levels, so consider each strategy on a case-by-case basis.
Apprenticeship programs
The SECURE act allows 529 plan funds to be used to pay for expenses related to apprenticeship programs. This includes trade schools and vocational programs, as long as the apprenticeship program is registered with federal Department of Labor. Eligible expenses include fees, textbooks, equipment and other supplies required for a registered apprenticeship. These programs typically combine on-the-job training with classroom instruction, often at a community college.
With traditional college costs rising and students not wanting to take on much student-loan debt, the inclusion of apprenticeship cost provisions may relieve some families’ concerns that funding a 529 plan may be a disadvantage if their child decides not to attend a traditional college.
The nuances: State regulations and timing
Now that you understand the changes to 529 plans, it’s important to understand your state’s interpretation of these new laws. Even though these are federal law changes, the regulations surrounding 529 plans are highly state-dependent, making it extremely important to know the rules for the specific state in which the 529 plan was opened. Account holders want to be cautious and check with their own 529 plan custodian before withdrawing funds. Account holders in states that do not go along with the new federal rules may inadvertently incur state income taxes and penalties or face a repayment of state tax breaks.
The timing of a distribution matters. The IRS only allows reimbursements from a 529 plan in the year an expense was incurred. However, the repayment of up to $10,000 of student loans in any given year meets this standard.
Even if your state does not conform with the recent changes to 529 plans, you can still take advantage of the federal tax benefits. Understand what steps you can take to maximize the advantages of these plans for your clients.
Sarah Mouser, CFP®, CTS™, CES™ is director of financial planning for Cassaday & Company, Inc., an award-winning independent wealth management firm in the Washington, D.C. metropolitan area. While Sarah and Cassaday & Co. focus on holistic planning, Sarah has a special passion and expertise surrounding education-planning topics.
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