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Do You Know How The Section 529 Tax Law Changes Affects You?

Years ago, there were very few ways to save for college, and before student loans came along, a lot of people just had to save in their now-antiquated passbook savings. Eventually, education IRA’s came along, and although much better than passbook savings replete with it’s 1099 at the end of the year, the IRA had so many limitations, soon college tuitions would dwarf those limits several times over. There needed to be a solution to the ridiculously widening gap between education IRA’s and the cost of college and our Atlanta bookkeepers and tax specialists were there watching the entire trend unfold.

The 529 Savings Plans were so revolutionary in its inception, though few understood it, within record time, they grew in popularity. The tax benefits were enough to encourage record contributions while the ability to allow another person in the family to use that same plan, in the event the beneficiary either did not want to go to college or got a scholarship, there were few reasons not to invest. The 529, originally a byproduct of a 1996 Small Business Job Protection Act, have seen trillions invested in them. The annual maximum contributions are $15,000, which really needs to be increased, but for space where there were almost no options forever, the 529 Savings Plans answered a lot of questions for parents.

Any time the government watchdogs go searching for money, they start to look at the largest tax-protected buckets of money. Unfortunately, 529 plans have grown fat enough to get some attention, and along with that attention has come new rules. Initially, the rules seem great, like how the funds can be used for financing schools from kindergarten to 12th grade, and then can be used for the original intended purpose, which was college funding. The idea it has been expanded to include kindergarten through 12th grade was welcome news to parents struggling, using taxable investments, to pay for these expenses. The caveat cannot be ignored, however.

The amount of money that can be withdrawn to help with the K-12 costs is capped at $10,000 annually, and any withdrawal amounts over that will be subjected to a 10% penalty. On a $20,000 withdrawal, that is a $1000 penalty. This is not welcome news with the average cost of private high school education in this country at $13,000 annually. A year at what is arguably one of the best private high schools in the country, Choate Rosemary Hall located in Wallingford, Connecticut, is $56,000. The penalties could totally add up under these circumstances.

This penalty, however, falls under the aegis of a federal “rule” and more than half of the states in the union remain noncommittal about whether they will adopt this rule or not. If all states adopt this rule, clearly it would be because it is fiscally to their advantage. In some ways, this might cause people to be financially more prudent, using the 529 investment as one way to harness the power of our markets to pay for their K-12 educations, while looking toward using other tools to finance lofty costs so as to avoid IRS penalties. Financial advisors can use this as a way to encourage even greater investments in these savings plans as well.

Like most things, on one hand, it is great news because the 529’s have been opened up for use for K-12 costs, but on the flipside, it is just a small amount of money that can be taken out, penalty-free anyway. After over 3 decades with the 529 Savings Plan being in existence, our Atlanta CPAs watched popularity in investing in these plans really gain traction. It was a welcome change, and this loosening of what the 529 Savings Plans can be used for is a step in the right direction that will likely trigger even more investments.

At the very least, some of the funds can be used for K-12, and in the case of a beneficiary who has a well-funded 529 Savings Plan, yet gets a fully-paid scholarship to the school of their choice, families were left wondering what to do with all those funds. At least now, if this rule is more widely adopted by most states in the union, parents could use funds to pay for the private K-12 education of a younger child. Perhaps this is just the beginning of more flexibility with these plans going forward, and this new rule creates even more reasons for financial advisors and investors alike to take investing in them very seriously.