Effect of Federal Tax Reform on 529 Savings Plans
How does the recent federal tax reform legislation (H.R. 1) affect 529 savings plans?
There are two major elements of the tax reform legislation signed into law on December 22, 2017 (H.R. 1) that impact 529 savings plans.
- First, up to $10,000 per year may be withdrawn from 529 savings plans, federal income tax-free, if used for tuition expenses at private, public and religious K-12 schools. It is not currently clear what public K-12 school costs, if any, will be regarded as tuition for this purpose.
- Second, the federal tax law now allows rollovers from a 529 savings plan account to an account in a 529A "ABLE" savings plan for the same beneficiary or a "member of the family" of the same beneficiary. The amount that may be rolled over cannot exceed, together with contributions from other sources to the applicable beneficiary's plan account, the annual limit on contributions to an ABLE account ($15,000 in 2018) without regard to the increased limit permitted for contributions by certain working beneficiaries.
Eligible Expenses and Tax-Treatment of Qualified Distributions
Will my distribution for K-12 education expenses be free of taxes?
The amendment to the federal tax code lists "expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school'' as qualified expenses and therefore federal income tax-free, subject to the $10,000 annual limit described above. Accordingly, to be eligible, a K-12 expense must be "tuition."
However, the treatment of such distributions for state tax purposes depends on the tax law of the applicable state. Because state tax laws relating to distributions from 529 plans were enacted prior to the change in federal tax law permitting federally tax-free distributions for K-12 expenses, the state tax status of such distributions may be unclear in some states. Moreover, it remains to be seen if additional regulations or restrictions will be implemented in states that offer a state income tax deduction or credit for contributions to 529 savings plans. Contact a tax professional to understand the tax impact of distributions for K-12 expenses in your state.
Expenses Other Than K-12 Tuition
Can the 529 plan be used for other educational expenses related to K-12 (e.g. SAT prep classes, GED, sports, aftercare programs or other school-related items?)
At this time, in order for a 529 plan withdrawal to be considered qualified (i.e. federal income tax-free), the withdrawal must be used to pay for K-12 "tuition" expenses. The IRS has not provided any guidance on whether anything other than a tuition bill from the applicable school qualifies as "tuition", and accordingly, other types of educational expenditures do not appear to qualify. It is also uncertain what, if any, expenses of K-12 public school will be regarded as tuition for this purpose.
Does the $10,000 distribution limit apply if it is used for high school classes that offer AP college credits?
The $10,000 limit applies to tuition expenses at an elementary or secondary school (i.e. K-12). Therefore, if AP classes are taken at a secondary school (e.g. a high school), the limit would apply.
Does the new tax law cover preschool if the preschool is at an elementary school?
The amendment to the federal tax code lists "expenses for tuition in connection with enrollment or attendance" at an elementary school as a qualified expense. However, preschool is not elementary school, regardless of where it is held, so tuition expenses for preschool would not be qualified 529 plan expenses.
Is the NJBEST Scholarship available when a beneficiary attends K-12 school?
No, the scholarship provided by the New Jersey Higher Education Student Assistance Authority to New Jersey residents participating in the NJBEST 529 College Savings Plan1 is only for attendance at an eligible New Jersey higher-educational institution and is not for elementary or secondary school attendance. The NJBEST Scholarship is subject to certain conditions and requirements. Please see the Investor Handbook for more complete information.
Moving Coverdell ESA Assets to a 529 Savings Plan
Are there federal income tax consequences for switching from a Coverdell ESA to a 529?
Amounts held in a Coverdell ESA can be moved to a 529 plan account for the same beneficiary with no federal income tax consequences, thereby allowing education savers to consolidate their education savings.
Where can I find additional information?
The new tax law can be reviewed at congress.gov.
The information provided above is based on our current understanding of federal tax laws and regulations and interpretations and guidance by the Internal Revenue Service, which are subject to change.
Important Legal Information
Tax benefits are conditioned on meeting certain requirements. Federal income tax, a 10% federal tax penalty, and state income tax and penalties may apply to nonqualified withdrawals of earnings. Generation-skipping tax may apply to substantial transfers to a beneficiary at least two generations below the contributor. Gift examples are general; individual financial circumstances and state laws vary--consult a tax advisor before investing. If the contributor dies within the five-year period, a prorated portion of contributions may be included in their taxable estate. See the Investor Handbook for more complete information.
Investors should carefully consider college savings plan investment goals, risks, charges and expenses before investing. To obtain the Investor Handbook, which contains this and other information, call Franklin Templeton Distributors, Inc., the manager and underwriter for the plan, at (877) 4NJ-BEST. You should read the Investor Handbook carefully before investing and consider whether your or the account beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in its qualified tuition program.
- Offered and administered by the New Jersey Higher Education Student Assistance Authority (HESAA); managed and distributed by Franklin Templeton Distributors, Inc., an affiliate of Franklin Resources, Inc., which operates as Franklin Templeton Investments. No federal or state guarantee. Principal value may be lost and investing in the plan does not guarantee admission to any particular primary or secondary school or to college, or sufficient funds for primary or secondary school or for college. Please refer to the Investor Handbook for more complete information.