Grandparents: Pump $150,000 into College 529 Plans

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Recent tax reform has opened up a whole new way for millions of American families to pay their child’s tuition from kindergarten through 12th grade at private schools, including religious schools.

Beginning in 2018, the new law allows parents to take up to $10,000 per child from that child’s 529 college savings plan to pay their K-12 tuition. That could come in handy, considering that the average cost of private high school is over $14,000, according to Private School Review, and in some states, it tops $30,000. So how can parents — and others who set up 529 plans for a child, such as grandparents and family friends — take advantage of the new law to fund their child’s private school education?

Let’s start by understanding the benefits of 529 plans. Created in 1996, these are education savings plans operated by a state or educational institutions to help families set aside funds for future college costs. Money earned in these plans is free from federal and state taxes, and isn’t taxed when withdrawn to pay for qualified education expenses. In addition, over 30 states currently offer a full or partial tax deduction or credit for 529 plan contributions.

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With this new funding option, parents or grandparents may wish to deposit a lot more into 529 accounts than they had planned. Keep in mind that while the IRS doesn’t limit the amount you can contribute, the overall balance in the account can’t be more than the expected cost of your child’s educational expenses — the amount varies by state, from $235,000 to $520,000, according to SavingForCollege.com. Here are some new scenarios to consider:

Grandparents Should Consider Large, One-Time Contributions to Offset Estate Taxes.

Beginning in 2018, each parent and grandparent will be able to contribute up to $15,000 annually per child and exclude these contributions from gift taxes. For example, a set of grandparents who are married, can make gifts of $30,000 to their grandchild’s 529 plan each year with no estate or gift tax consequences.

In addition, grandparents may want to consider making a large, one-time contribution and choose to spread it over five years as a way to possibly avoid future gift or estate taxes.

Here’s an example. A grandparent who is married can deposit $150,000 into their grandchild’s 529 plan to cover K-12 expenses — an amount equivalent to a $30,000 contribution each year over five years. When filling out their federal tax forms in 2018, they can elect to include this gift over a five-year period (i.e., $30,000 x 5 = $150,000), thereby excluding the $150,000 from any gift taxes.

Assuming the grandparents live five more years, the entire $150,000, plus the money earned from this investment, will not be taxed as part of their estate. And after this five-year period elapses, they can deposit an additional $150,000 if they want to ensure their grandchild has an Ivy League education, free of student loans. Keep in mind that contributions to irrevocable trusts count toward annual and lifetime gift tax limits, so be sure to consult your CPA before making large deposits into a 529 plan.

Take Advantage of State Tax Credits and Deductions.

If your state offers an income tax deduction for a portion of each year’s contributions, determine if you can use an “in-and-out” strategy to pay for K-12 tuition.

Each person and their financial adviser should check state plan rules, but it’s possible for a parent to deposit $10,000 in 2018, receive a full or partial tax deduction on their 2018 state tax filings, and also withdraw the money in 2018 for private school tuition. To receive the tax credit or deduction, you must be the account owner of the 529 plan.

For example, in New York, a married couple where one of the parents is the account owner can deduct up to $10,000 in 529 plan contributions per year on their state tax return. This move would enable this couple to save $600 to $800 in state taxes annually.

A Deeper Dive into 529 College Plans

Invest Conservatively for K-12 Expenses.

Most 529 plans offer a variety of investment choices. To guard against potential losses, the funds to be used for K-12 expenses should likely be invested more conservatively compared with funds for a child’s college education.

Because a parent has 18 years to allow money in 529 plans to grow and pay for college expenses, a portfolio with a heavy dose of stocks is usually the best course to take. But parents needing money in 529 plans to pay K-12 private school expenses could have as little as one year before the funds are needed. It’s more appropriate to keep this money in short-term bonds, which are less risky. It’s also possible to have more than one investment selection inside a person’s 529 plan, so consider this option if planning to use the account for both types of education expenses.

Consider the Downside of Spending 529 Funds Now Vs. Later.

A couple who decides to withdraw $10,000 annually from their 529 plan to cover K-12 tuition expenses will begin to drain the money needed for college costs. And taking large amounts out of the account each year will also limit the parents’ ability to benefit from tax-free growth inside the 529 plan.

In addition, parents who are saving for college now and would like to retire early without college debt hanging over their heads (or their children’s heads) may not want to cash in the 529 plan money early. Why? Spending their child’s 529 plan for K-12 expenses now may mean working longer to pay those big college bills.

But make no doubt, the new federal tax law provides parents and grandparents with more options to pay for the young child’s education. Parents and grandparents should develop a long-term financial plan before taking funds out of the 529 plan for K-12 tuition costs. Weighing the short- and long-term impact and benefits will help you make important decisions about one of your most important financial goals — how to fund a child’s education.

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Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Lisa Brown, CFP®, CIMA®, is author of "Girl Talk, Money Talk, The Smart Girl's Guide to Money After College” and “Girl Talk, Money Talk II, Financially Fit and Fabulous in Your 40s and 50s". She is the Practice Area Leader for corporate professionals and executives at wealth management firm CI Brightworth in Atlanta. Advising busy corporate executives on their finances for nearly 20 years has been her passion inside the office. Outside the office she's an avid runner, cyclist and supporter of charitable causes focused on homeless children and their families.