Saving in 529 plans for your children or grandchildren has become more attractive with the recent tax law changes. Today, I will explain two such advantages that you must know if you’re thinking of 529 plans.
TCJA allows penalty-free and tax-free distributions from 529 plans for K-12 Private education
First of all – until 2017, you were able to take penalty-free and tax-free distributions from your 529 – only if you use the money for your child’s college education.
This has changed when the Tax Cuts and Jobs Act came into existence starting in 2018.
You are now allowed to withdraw from the 529 plan and pay for your child’s K-12 private education – without having to pay federal taxes on the earnings portion of your 529 funds.
That said, there are a couple of points to note:
1) Qualified withdrawals for K-12 education are limited to $10,000 per year, per beneficiary. Yes, that’s true. The $10,000 limit is per beneficiary. So, if you have multiple beneficiaries, you can withdraw up to $10,000 from each beneficiary’s plan without worrying about federal taxes.
2) Unfortunately, not all states conformed to the law. If your state has not conformed to the law, while you can avoid federal taxes on the distribution, you are still subject to state taxes on the earnings portion of the distribution.
So, if you are considering sending your child to a private school, 529 plans offer a tax-efficient way of saving towards that goal – Thanks to the 2017 Tax Cuts and Jobs Act.
SECURE ACT allows tax-free, penalty-free distributions from 529 plans to pay off student loans
A second advantage comes from the more recently passed SECURE Act. Before the SECURE Act, if you pulled money out of a 529 plan to pay a student loan, you were liable to pay taxes and penalties on the distribution. In other words, the distribution is not considered “qualified”.
Not any more – with the SECURE Act.
You are now allowed to take tax-free, penalty-free distributions from 529 plans to pay off student loans.
This, in fact, provides a great opportunity if grandparents are saving in a 529 plan for their grandchildren. Here is how.
Typically, all distributions from a grandparent-owned 529 plan are considered student’s income in the year of distribution. And 50% of this income is considered a student’s responsibility while calculating the student’s financial aid package. This income is likely to impact how much financial aid the student will ultimately receive.
Why?
Because the student is required to pay 50% of this income towards college expenses before financial aid kicks in.
So, in order to maximize the student’s financial aid package, grandparents can wait until the student graduates and use the 529 funds to pay off their student loans instead.
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