The Tax Cut and Jobs Act signed into law in December made an important modification to a widely used college savings vehicle—529 college savings plans can now be used for qualified K-12 educational expenses. Advisors will undoubtedly be questioned by their clients about this new opportunity, and should be prepared to provide some perspective as to how it could impact or improve upon both new and existing educational funding strategies.
To date, 529 plans (savings vehicles which enable tax free growth) have been strictly for qualified, college-related expenses. Now, as a result of the new law, state-sponsored 529 plans can be used for “tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious elementary or secondary school.” There is, however, a $10,000 a year per student limitation for K-12 expenses as opposed to qualified college expenses that have no annual distribution limit.
Since the number one benefit of 529 plans is tax-exempt growth, the longer the compounding time, the greater the potential benefit. So, households that have been diligently stashing away money every month for anticipated college expenses should think carefully before tapping those funds early.
Just because you’re allowed to do it does not necessarily mean it’s the right thing to do. It may make good sense to use 529 dollars to satisfy a portion of K-12 expenses, but only under certain circumstances. Depending on a client’s particular situation, it may even be beneficial to contribute additional funds to a 529 in the expectation of using the funds for pre-college expenses.
Here Are Five Considerations:
1. Focus On College First
First and foremost, before you advise your clients to consider using their children’s existing 529 money for K-12, be sure that they have already achieved their higher education savings targets first. Since college is one of the most significant expenses households will face (typically ranging from $80,000-$300,000 in today’s dollars for a child’s four-year higher education), even high-income households will be hard pressed to plug those costs into their annual budgets without some advanced planning. This is especially true for those with multiple children attending college at the same time.
Since 529s can be switched to other family member beneficiaries or used for graduate school, determining the educational funding status should be done on a family aggregated basis. So, unless you are confident that your client has overfunded the total expected family college costs, then they should hold off on tapping those funds early for K-12 and enjoy the power of compounding.
2. Is There More Funding Capacity?
If you are comfortable your client has already over-funded their family’s aggregated college savings goals, using a 529 fund for K-12 is a reasonable thing to do. However, if your client is still working towards achieving a goal, upping 529 contributions for expected K-12 expenses could also be of benefit as long as there is capacity to do so.
Capacity comes into play in two ways: (i) how much remaining room is there to fund a current 529 plan before hitting the plan’s aggregate limit, and (ii) is there unused annual gift exclusion capacity?