The Puzzle: Blog

We assume the word is spreading among the independent school community. But just in case, we thought we’d let our readers know. For independent schools, a major change in the Tax Cuts and Jobs Plan passed by Congress in late 2017 is that tax-free 529 savings plans — originally designed to encourage parents to save for their children’s college tuition — can now be applied to K-12 education. As the tax plan itself puts it, 529’s can now be used for “expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school.”

This change was a last-minute amendment to the bill in December 2017 added by Senator Ted Cruz (R-Texas).

Prior to the change, the only way to save tax-free for private K-12 education was through a Coverdell Education Savings Account. But those accounts have significant limits that don’t apply to 529 plans.

Here are the essentials for using 529 funds for precollegiate tuition:

• A 529 plan now can be used for up to $10,000 a year for K-12 tuition and other related expenses. (Additional distributions will be subject to a 10% federal penalty.)
• “Other related expenses” include books and other printed educational materials, online educational materials, tutors (who are not related to the student), cost of dual enrollment at an institution of higher education, and “educational therapies for students with disabilities.”
• The funds cannot be used for homeschooling.
• Families that have been using the Coverdell Education Savings Accounts can roll them over into 529 plans.
• Contributions to a 529 plan vary per state, but they are generally very high. (For example, California sets the maximum at $475,000, and Michigan allows up to $500,000.)
• At the federal level, contributions are not tax deductible, but earnings accumulate tax-free.
• Anyone can contribute to a child’s 529 plan. Outside contributions to these savings plans — e.g., from grandparents — qualify for the gift-tax annual exclusion, which is $15,000 per recipient in 2018 ($30,000 for benefactors who are married).
• The 529s are administered by states, not the federal government. More than 30 states offer a deduction or credit contribution to a 529 plan.

While all this may sound straightforward, changes to the 529 plan to include K-12 schools are not without controversy, concerns, and questions.

Critics view this shift as just another tax break for the wealthy — or as an opinion piece by Ron Lieber in the New York Times calls it, “a brazen giveaway.” They point out that because the change can entice a lot of new families to sign up for 529 plans to cover tuition paid to private schools, it can also have a large impact on state tax revenue.

For schools, the bill may raise questions about how they’ll set their financial aid policies in light of 529 plans. As Lieber suggests in the Times, “Board members and administrators at private elementary and secondary schools are going to have to take a hard look at making a direct ask for some of that 529 money from families that are applying for tuition discounts.”

In a recently posted update, attorneys working with the National Association of Independent Schools (NAIS) also point out that not all states are willing to allow families to use their 529 plans for precollegiate education. As they note, both New York State and Illinois currently do not allow 529s to be used for K-12 expenses and “warn that families who do so may be subject to claw-back of state tax benefits they previously received.”

Indeed, in a January news release, Illinois State Treasurer Michael Frerichs indicated that families that use of the state’s 529 plan to pay for elementary or secondary tuition would violate the state’s tax code. New York State issued a similar preliminary view on the use of 529 plans for elementary and secondary education.

Missouri and Mississippi, on the other hand, have cleared the way for the use of 529 funds for elementary and secondary education. According to the Council for Private American Education, most states will have to enact some sort of legislation to clarify the use of 529 funds.

Because we are not tax accountants or investment advisors, we’ll stay away from wading deeply into all the possible variations on what the change to 529 plans will mean to any individual investor or, for that matter, what it means for schools and colleges.

We can only suggest that schools check with state tax officials and the operators of 529 plans. Parents interested in setting up 529 accounts for precollegiate expenses should confer with a trusted advisor.

Some useful links:

The Tax Cuts and Jobs Plan

States Assessing Impact of Federal 529 Change (CAPE Outlook)

529 Plan Update: Taxes Benefits May Vary by State (NAIS)

Yes, You Really Can Pay for Private School with 529 Plans Now

Saving for College

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