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Planning to use a 529 plan for your child's private high school tuition? Not so fast.
The massive overhaul to the federal tax code redefined the education investment funds. Now, the accounts can be tapped not just for college expenses but for K-12 private school tuition, as well. That means withdrawals for either purpose are exempt from federal taxes, regardless of whether you live in Vermont or Kentucky.
Yet many states are still trying to figure out if their own tax benefits apply to savers who turn to the accounts for private elementary, middle or high school tuition bills.
If you use your 529 plan for K-12 expenses and live in a state that doesn't consider those costs as qualifying, you may have to pay state income taxes on those withdrawals. In addition, any state income deductions you claimed for making your contribution could be cancelled.
Last year, many states, including Arkansas and Wisconsin, introduced legislation to include K-12 tuition as a qualifying education expense for their 529 plans. As a result, residents in those states can deduct their contributions for those costs from their state income tax bill, up to a certain amount.
Other states, such as North Dakota and Georgia, have set up their education saving account policies to automatically conform to the federal law and so no legislation was needed.
"The movement in general across the states has been toward conforming to the federal law," said Sharmila Mann, the director of policy at the Education Commission of the States, which has been tracking how states respond to the new code.
However, some states have resisted extending their tax perks to people who want to use the accounts before college.
Colorado, New York and Nebraska introduced legislation to expand their plans' tax benefits to K-12 savers. All three bills failed.
Some states may be weary of giving out additional tax deductions and credits, said Mark Kantrowitz, the publisher of SavingForCollege.com. "It can be an unbudgeted decrease in state income tax revenue," he said.
Other states might simply be putting off changing their existing tax code, said Elaine Griffin Rubin, senior contributor and communications specialist at Edvisors.
Despite the state of flux, the plans have never been so popular.
Studies show that children who have the accounts are more likely to attend college. And if you start to contribute to a plan at your son or daughter's birth, about a third of your savings goal could come from investment earnings alone, according to calculations by Kantrowitz.
Just make sure you understand what your state does and doesn't allow with their 529 plans, said Mann, the director of policy at the Education Commission of the States.
Some states are already creating specialized 529 plans just for pre-college expenses, Kantrowitz said.
"For many families, it might be best to have two 529 plans, one for K-12 and one for college," he said. That's because your investment strategy will likely be different from one to the other.
"If you're saving for K-12 from birth, you may have only five years before you need to start using the money, while you may have 17 years before you need to use college savings," Kantrowitz said.