The Tax Cuts and Jobs Act of 2018 was one of the largest sweeping set of tax code changes in history. Among one of the lesser known changes was an alteration to the rules impacting the utilization of 529 savings plan assets. It opened the door for change in the way families utilize 529 plan savings in Iowa and around the country.

State of Iowa Tax Benefits

529 plans have historically been used for funding higher education. In certain states, Iowa included, contributors are eligible for tax deductions on contributions made to 529 plans. For example, in Iowa Mom and Dad may each contribute and receive a deduction up to $3,318 in 2018 for each child. If they have two children, they may each contribute $6,638 for a total deduction of $13,276.

They may contribute to the plan for the current tax year up until the tax filing deadline of the following year, generally by the end April. Grandma and Grandpa may want in on this action as well, and they can do the same.

Federal Tax Benefits

On the federal level there are no tax deductions on contributions made to a 529 plan. However, there is a different incentive. The assets held in the 529 plan grow tax-deferred, and if used for qualified higher education purposes the money may be distributed tax free.

What constitutes higher education? What expenses may 529 resources be allocated to? The answer to these questions is a bit complex. However, anyone with a smart phone or an Internet connection can find guidance on the details. The IRS website for example is a great place to begin. It’s surprisingly easy to navigate and relatively clear about what you can and cannot use 529 money for. The list of items is quite extensive. From tuition, room and board to books and supplies. Many other expenses associated with attending college are also included. Even technology like computers and tablets may be included in what you may use 529 money to pay for.

K- 12 Tuition

Prior to 2018 it was not permitted to use 529 money to pay for K-12 education. However, as a result of passing the Tax Cuts and Jobs Act of 2018 this has changed. Families whose children attend religious and private k-12 school programs are now permitted to use 529 money to cover the cost of tuition and receive the federal tax benefits previously described.  

If Mom and Dad have a child attending Dowling Catholic or Ankeny Christian for a K-12 education they may now use 529 savings to offset some of the costs of attendance. Specifically, up to $10,000 may be withdrawn federal income tax-free to cover tuition for each child enrolled per year.

The tax benefits for K-12 are specific to tuition only. Families are not permitted to use 529 money to buy books, technology like computers, or anything else. The Tax Cuts and Jobs Act specifically changed the 529 rules to apply to tuition only and excluded other potential expenses associated with K-12 education.  

What Are the Real Benefits?

If you think about it, the federal tax benefits of a 529 plan only apply to the growth on your contributions. To really be effective you would have to contribute to a plan, and then have it earn a significant return over the contributions. The growth on the savings would be tax-deferred, and then you could pull it out tax-free. Long term growth is key to enjoying the Federal tax benefits of a 529 plan. Therefore, if you’re thinking of using a 529 plan money to pay for K-12 tuition in the short term, federal tax benefits may not be all that relevant.

However, in a state like Iowa that permits a tax deduction for contributions to a 529 plan there is an immediate tax benefit for contributing. Each state is different, and you must understand your state tax laws in order to take advantage of what is available to you and your family.

Specifically, in the state of Iowa a family can contribute to a 529 plan, and receive the tax deduction. The same family can then immediately distribute those funds to pay for qualified K-12 programs, as well education or higher education. As long as the funds are used for a qualified expenses, and an institution with in the state of Iowa you keep your tax deduction. If you use the funds for an educational institution outside of the state of Iowa you will forfeit your tax deduction.

Think about this for a moment. Your family may have children going to a parochial school paying nearly $10,000 year for education. You can contribute up to $3,319 per person per child. A husband and wife with two kids could each contribute $6,638 per person for a total of over $13,276 to a 529 plan and get the tax to duction in Iowa. Then you can immediately turn around and use those dollars to pay for a portion of the tuition cost of sending your child to the private school.

Currently Iowa allows this practice, and hasn’t taken any measures to curb the behavior. However, not every state allows this. I recently met with a woman who lives in Iowa and wanted to contribute to a 529 plan for a grandchild to be used for school in Montana.

In her case, she can contribute to the 529 plan for her grandchild but she will not get a tax deduction for the state of Iowa utilize enough money to pay for K-12 education for in Montana. This is because the institution is outside of the state of Iowa.

Through our investigation we became familiar with the Achieve Montana 529 program. We learned that contributions to Montana 529 plan will earn a tax deduction for the Montana resident contributing. That’s good!

Therefore, this woman’s daughter could contribute to a 529 plan for the grandchild, and then get a text deduction on her Montana state tax return.

However, Achieve Montana rules are different from Iowa’s 529 program. In this case the women’s daughter would not be able to withdraw on the 529 contributions immediately to pay for the grandchild’s tuition. Montana’s program language contains a provision that requires a three year hold before withdrawing funds. If the money is used prior to the expiration of the 3-year period the tax deduction original received on contributions is clawed back.

Are 529 Plans Right for Your Family?

When it comes to understanding whether a 529 plan makes sense for you and your family education goals there’s much to consider. It’s best to know all the rules first. Understand the federal rules. How do those apply to you and your family within the estimated timeline you intend to use the money? Will you reap the benefits of the 529 rules, or do they sound better in theory than in practice for your specific needs? Do they actually make good financial sense for your family?

Then consider the state rules. How will Iowa’s (or your specific state) rules apply to your family’s plans for education. Will the tax deductions received on contributions be worth the effort? Might there be any unintended consequences of contributing to a 529 pan that should be considered first?   

Working with a knowledgeable college planning firm may help answer these questions as well. How will 529 savings effect the financial aid application process. Will they impact your family’s chances of securing financial aid that may otherwise be available in the absence of 529 savings?

Become familiar with tax rules regarding 529 plans. Understand the financial aid processes utilized by the majority of colleges and universities nationwide. Then make decisions about how much your family may benefit from 529 savings plans. It’s OK to seek advice. Some financial professionals understand college funding, and are proficient in the rules regarding Financial aid and higher education savings plans like 529‘s.

“Investment Adviser Representative of and advisory services offered through Royal Fund Management, LLC, a SEC registered investment adviser.”

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