Tax Reform and Tuition

Written by Gabe Aaronson on . Posted in Community News

Answers to your questions about using 529 savings accounts to pay for private school.

For 21 years, tax-advantaged 529 savings accounts could only be used to pay for college expenses. Now, thanks to the tax reform signed into law on Dec. 22, they can also be used to pay for K-12 private school tuition.

So, what exactly are 529 savings accounts, how do they work, and how will Jewish day school and other private school parents benefit from the recent change?

What is a 529 Plan?

In 1996, Congress created the 529 plan to help families save for college. The idea is that parents put money into a 529 account, the money is invested over time, and any investment income is untaxed. If someone invests $10,000 when their child is born, then over 18 years, they could gain $18,500 in untaxed investment income (assuming a 6 percent annual return).

Any money in a 529 savings account must be spent on college expenses, such as tuition or room and board. Additionally, to benefit from a 529 savings account, a family must make enough money to 1.) have some for savings after paying day-to-day expenses, and 2.) be in a high-enough tax bracket to benefit from untaxed investment income. These two points are why wealthy families benefit most from 529 savings plans. According to the Government Accountability Office, nearly half of families with a 529 plan have incomes over $150,000.

Although 529 plans offer federal tax benefits, only states can operate 529 plans. Most states offer extra benefits to residents who enroll in their state’s plan.

How did the tax reform law change 529 plans?

Previously, only college expenses counted as a “qualified expense” for 529 savings accounts. Spending money on anything other than a “qualified expense” means paying taxes on that money, plus a 10 percent penalty.

Now, primary and secondary private school tuition also counts as a “qualified expense.” One can spend up to $10,000 per child per year on tuition at a K-12 private school.

Are tuition payments tax deductible if they go through a 529 account?

For federal income tax: no. For state income tax: yes, within limits.

Under federal law, only investment income from — not actual contributions to — a 529 savings account are untaxed.

Under state law in Maryland and Virginia, and under DC law, however, both investment income and contributions themselves are untaxed when calculating state income taxes. The top income tax bracket ranges from 5.75 percent in Virginia to 9.2 percent in DC, so this could mean a significant boost for private school families who filter tuition payments through 529 savings accounts.

Most states limit how much of a contribution to a 529 account is deductible each year. For couples, it’s $5,000 in Maryland, $4,000 in Virginia, and $8,000 in DC, although excess contributions can generally roll over to future tax years.

How can people maximize day school tuition savings through 529 accounts?

Before doing anything, speak with an accountant. A professional can explain, based on individual circumstances, how best to take advantage of the change.

In general, it makes sense to front-load 529 accounts. This means that once a child is born, place as much money as possible (up to, say, $80,000) into the account so that it starts accruing tax-deductible investment income. Every dollar invested during a child’s first year of life could be worth $1.25 by the time they start kindergarten, and the extra 25 cents is tax deductible.

Don’t forget that anyone can contribute to a 529 account, so grandparents who plan on helping with tuition should start contributing as soon as the baby is born.

Maryland families with children of any age should open a 529 account, as the state matches the first $250 per beneficiary (but only once per child, and only for families with incomes below $175,000).

And it will probably pay to act sooner rather than later. States can’t control federal tax policy, but they have considerable leeway over the state tax benefits they offer. If legislators in Maryland, Virginia, or DC decide they don’t want to subsidize expensive private school tuition, then they might (for example) limit benefits for families over a certain income threshold.

By Gabe Aaronson

 Gabe Aaronson does IT project management for the Defense Health Agency and public policy consulting for various clients. He lives in Kemp Mill, Maryland, with his wife and two daughters. Email This email address is being protected from spambots. You need JavaScript enabled to view it. .