How to Use the New Tax Bill to Send Your Kids to Private School

A provision now lets you use 529 plans to pay for elementary, middle, and high schools. But there are a few caveats.

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The Tax Cuts and Jobs Act was a lot of things. A big tax break for corporations and many families. An attempt to undercut the Affordable Care Act by removing the individual mandate. But no one really labeled it as a clever gambit to reform the U.S. educational system. But it is if that’s how you classify a financial break that makes private school significantly more affordable — and thus a more viable alternative to public education.

Tucked inside the 1,097-page bill is a provision that lets you use state-administered 529 plans – long a bedrock of college savings – for elementary, middle and high schools, too. Now parents and grandparents can withdraw up to $10,000 a year, tax-free, as long as they use the money for tuition and other qualified expenses. When compared to a traditional investment account, where the IRS takes a chunk of the capital gains, dividends or interest you earn, they’re a compelling option.

Many states provide incentives of their own as well. Thirty-four of them – along with the District of Columbia – give state income tax deductions or credits when you make a 529 contribution.

How many of the plans will extend state-level benefits to K-12 education is still unclear. “About 30 states have language that’s compatible with the new law,” Jim DiUlio, the chairman of the College Savings Plan Network, told CNN last week. “But about 20 still have to make changes to legislations to comply.”

The state treasurer of Nebraska, for example, says it would require new legislation to comply with the new federal rule. Administrators in other states are still trying to determine the legal fallout. The website for Bright Start, the Illinois 529 plan, reads: “At this time, it has not yet been determined whether and how the Illinois statute that establishes the plan may be modified to include this expanded definition.”

So while you can count on a tax break from the IRS, some parents still have to wait for assurance that they’ll get help from the state, too.

For those who live in a state that’s already in compliance with the new law, it doesn’t take much foresight to achieve a nice tax benefit. If your child is already enrolled in a private school, you can use 529 funds that you invested just a few weeks or months earlier; you’ll still reap whatever tax incentives your state offers at the end of the year (only Wisconsin and Montana have minimum time requirements for 529 contributions).

Long-term savers, however, enjoy the biggest rewards. By starting when your child is an infant, you’re letting the underlying investments grow over a longer period of time — and none of the interest or capital gains you earn will go to Uncle Sam if you apply them to your kid’s tuition bill.

According to Savingforcollege.com, a family that earns $150,000 a year and puts $300 a month into a 529 would have $75,654 after 14 years. Had the same money gone into a taxable account, they’d end up with $8,339 less.

Those in the highest tax brackets get an even bigger break. That raises the prospect that some parents will fund their educational accounts with large lump-sum contributions. Conceivably, you could put, say, $150,000 into 529 when your child is born and let the money grow for several years on a tax-deferred basis.

Those families would be able to take out up to $10,000 annually for elementary and secondary schooling. They could use the remaining amount for college, where the rules are less restrictive (For instance, parents can withdraw the entire cost of things like tuition, books and room and board for the year)

And what if you’re in an enviable scenario where the student still hasn’t used all the funds in their account after college? You can avoid a penalty by simply saving it for grad school or transferring it to another member of the family.

So far, so good. But what do private schools do about the extra money now falling into mom and dad’s pocket? It’s certainly possible that administrators will seek to share the windfall by raising tuition.

Andrea Feirstein, a consultant who advises 529 plans, told the New York Times that K-12 schools may also start factoring the accounts into financial aid decisions. So, alas, all that money you thought you were stowing away for college could become fair game.

On whole, though, the new rules are still good news for private school parents. In fact, once the benefits become “baked” into the educational system, it becomes more incumbent on parents than ever to start saving early and seize the largest possible tax benefit.  

Politically, the changes have proven contentious, even among some school choice advocates. Whereas vouchers, for example, create more options for low- and middle-class families, the biggest winners of the expanded 529 are families at higher income levels, many of whom will send their children to private school with or without a tax benefit. It’s also a threat to state coffers, as many of them will be doling out more extravagant tax benefits to 529 owners.

For families who are already sending their kids to a private school, or want to, that’s neither here nor there. The rules of the game have changed, and you’d do well to adapt.

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