What the new tax law means for your college savings plan

Key Points
  • 529 plans allow you to save money on a tax-advantaged basis and withdraw from the account free of taxes for qualified educational expenses.
  • You can contribute up to $15,000 per year to a beneficiary’s 529 plan.
  • Under federal law, savers can now withdraw up to $10,000 to pay for students’ private K–12 tuition. Be sure you understand whether your state allows this, or else you may face taxes.
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Investing in a 529 plan

Your trusty college savings plan is no longer just for higher-education costs, thanks to the new tax law.

Whether you have young children or grandchildren, you're probably aware of the rising cost of higher education: The average annual cost of tuition, fees and room and board at a four-year private college rose 3.5 percent, to $46,950, for the 2017—2018 school year, according to data from the College Board.

That figure hit $20,770 for in-state tuition at a four-year public institution, the College Board found.

Families can save for those expenses using a 529 plan, which permits you to invest your money without being subject to tax. You can withdraw from the account to pay for qualified educational expenses free of taxes.

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You can contribute up to $15,000 per year for each 529 beneficiary.

Here's what's new. The Tax Cuts and Jobs Act added an extra level of functionality for 529s: K–12 private school tuition.

This may upend the way you save in these accounts.

"Now that you can use the money for K–12 private-school education, be aware of what the time frame is in which you're investing money in the 529 plan," said Douglas Boneparth, a certified financial planner and president of Bone Fide Wealth.

Decide which state's plan is right for you

Under the new tax law, you can use up to $10,000 a year for each beneficiary to pay for elementary or secondary school tuition.

Be aware, however, that just because the federal government is greenlighting your use of a 529 to cover K–12 tuition costs, that doesn't mean that your state will permit it. Every state's plan is different, and you are under no obligation to select your own state's 529 plan.

More than 30 states offer their residents a deduction or credit on their state tax return for saving in a 529 plan, according to Savingforcollege.com. Yet some of these jurisdictions will hit residents with taxes, penalties and clawbacks of their tax breaks if they use their 529 savings to pay for K–12 tuition expenses.

Find out whether your state will permit you to use your plan this way.

Value of 529 tax break 180404 EC Mercado
Save early
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"The best time to open a 529 plan is probably after the birth of that child," said Boneparth. "This gives you the most amount of time to let money grow."

Be mindful of how you plan to use the money: Your child will miss out on years of compounding interest if you withdraw money for primary and secondary school.

"It might not make a lot of sense to make a contribution only to use it that year or in the short term," said Boneparth.

Saving less in the present will mean borrowing more once college sets in, which could lead to heavy student-loan debt.

Do your homework

When performing your research on 529 plans, be sure to learn more about investment expenses, as well as enrollment and maintenance fees: Spending less on these costs will amount to more of your contribution being invested.

Be aware of the investment options available to you.

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Full exposure to the stock market may be just fine if you're opening an account for a newborn, but it's probably a terrible idea if your child is two years away from starting college.

Finally, consider advisor-sold plans versus direct-sold plans.

Direct-sold plans, which you can buy without the help of a financial advisor, tend to be cheaper.

Ask yourself whether the advisor's guidance is worth a commission or a separate fee for planning.