A highly tax-advantaged investment plan for funding college education expenses, now allows the use of this money for private elementary and secondary schools, including parochial schools.
Beginning this year, a new windfall is available to parents of children attending private elementary and secondary schools.
A highly tax-advantaged investment plan for funding college education expenses, long a staple of many parents’ investment portfolios, now allows the use of this money for expenses of private elementary and secondary schools, including parochial schools.
Effective this year, federal rules allow the use of these plans, called 529 plans, 12 years sooner by allowing withdrawals for qualified education expenses of private and secondary schools. Previously, money invested in 529 plans could only be tapped without penalty for post-secondary education expenses.
These plans are administered by states and, within limits, many states offer tax deductions (some even offer tax credits) on the money put into them. Additionally, there are no state or federal taxes on withdrawals to pay qualified education expenses.
To get the most out of these plans, consider this example of what I call “super-funding” a 529 account — a financial strategy accessible to wealthy families. Let’s say you have a young child about to enter the first grade. You’ve been making substantial contributions to a 529 in recent years, and before your child enrolls, you have $200,000 in your 529 account and have chosen from the plan’s menu of available investments to grow your money (primarily mutual funds). Then, when your child enters school, you withdraw $10,000 a year (the maximum allowable annual pre-college withdrawal per child) toward tuition, room-and-board and other qualified expenses of your child’s private school. Qualified expenses also include books, software and equipment, according to Capital Accounting Group in Phoenix, Ariz.
By making these $10,000 withdrawals from a 529 plan to pay for grades one through 12, you avoid having to pay nearly $2,500 in taxes (including taxes on investment gains), saving about $30,000 by the time your child graduates from high school.
Even after these withdrawals, if your account is growing at 6 percent a year from gains from investments within it, you’ll have more than $370,000 left for college — without making any contributions beyond the initial $200,000. This example assumes that you’ll be using all of this money for this purpose, as IRS rules limit contributions to the amount necessary to pay qualified education expenses. Depending on how much your eldest child’s college education costs, you could still have a substantial amount left over to educate your other children — and you should plan to do so to stay within IRS rules.
It gets better. A few states even allow tax deductions on contributions to plans sponsored by other states, which encourages parents to cross state lines to use plans that may be superior to those offered in by their states of residence. Like 401(k) plans, these plans can vary considerably in investment options, fees and thus, in potential returns. A key reason for this is that states choose different financial institutions to hold their plans.
So it’s a good idea to shop around the country for the best 529 option. Look for states whose plans enable a tax deduction on contributions in your state and also offer the best potential returns. State-by-state information can be found on the website, savingforcollege.com.
These plans can be used not just to pay for the pre-college and college education for your children, but also those of extended family, including nieces, nephews and grandchildren — and even for your own education expenses, should you choose to go back to school. And if one of your children gets a scholarship, you can — and should — use the 529 plan you started for that child to pay the education expenses of your other children.
If you have children headed for private elementary or secondary school and don’t have a 529 plan, the windfall provided by the new rules makes it time to consider one. Even if your kids will attend public schools until college, it’s still a good idea to establish a plan as soon as possible to accumulate tax-free investment gains — and in some states, receive tax deductions or even credits on contributions — as long as possible before you write the first college tuition check.
David Robinson, a Certified Financial Planner, is founder/CEO of RTS Private Wealth Management, an SEC-registered firm in Phoenix that provides fiduciary services to help clients achieve their financial goals. His practice focuses on helping wealthy individuals with custom financial plans, using a holistic approach to grow/protect wealth, manage taxes, identify insurance solutions, prepare for retirement and manage estate plans.