529 College Savings Plans provide you the opportunity to invest and save for college education and meanwhile get the benefit of tax free growth and withdrawals, so long as the withdrawals are used to pay for qualified education expenses. Tax free always has a special ring to it, doesn’t it?
Originally the 529 plans were specifically to be used on college education expenses. But in 2018, they updated the withdrawal limitations to include the opportunity for families to withdraw up to $10,000 per beneficiary, per year for K-12 tuition at private and parochial schools.
Yet another reason to consider investing in the 529 plans for your children’s education costs.
The Two Main Benefits of Contributing to a 529 Plan
- Tax Free Growth and Withdrawals – as long as you use the funds towards qualified education expenses
- Potential tax deduction on your state tax return if you contribute to a 529 college savings plan (each state varies)
Each of these benefits provide a reason for you to consider contributing to the 529 plan if you see private school and/or college education in your children’s futures. But let’s look at the numbers below to make sense of it.
Tax Free Growth Offers Up Additional Cash Flow for Education
If you contributed $10,000 today into a 529 College Savings Plan for your newborn baby with the plans to send him/her to private high school, then you would benefit from years of compounding tax free growth in the account.
- Assuming a 7% annual rate of return, the original $10,000 would turn into roughly $29,000 of funds to be used over the course of their first few years of private high school.
- You would take $10K (the allowable amount for K-12) out for the first year of high school, $10K out the second year and an additional $9K out the third year. Thus providing you with an additional $19,000 of tax free cash flow to help pay for private high school.
- You would take $10K (the allowable amount for K-12) out for the first year of high school, $10K out the second year and an additional $9K out the third year. Thus providing you with an additional $19,000 of tax free cash flow to help pay for private high school.
Increase that original contribution, contribute for multiple years or even leave it in longer for college…. and the impact will be even greater.
The earlier you invest in this tax free vehicle, the more potential there will be for months or years of college or private school tuition to be paid for by tax free investment earnings!
The Real Tuition Wealth Hack:
Contributing to & Withdrawing Funds from a 529 Plan in the Same Year
The benefit you receive will depend on a few different factors: the state in which you live, the state 529 plan you are contributing to and what your state income tax rate is. But needless to say, for many individuals in most states, there may be a benefit to using this strategy.
What would happen if you contributed money into a 529 plan and then subsequently withdrew the funds in the same year?
This strategy would be an attractive option for anyone currently paying for private school, undergrad or graduate programs out of pocket.
Let’s Look at a Few Examples:
New York Resident Contributing to a NY 529 Plan:
If you were a NY resident filing jointly and contributed $10,000 to a NY 529 plan and then subsequently took it out in the same year to pay for private school or college, the benefit to you would be this:
- Let’s say you pay approximately 7% in NY state income tax. You are filing married filing jointly and thus receive a state deduction for $10,000 to offset your state taxable income as a result of contributing $10,000 to the NY 529 Plan. You will have saved $700 in taxes…and in theory, on your tuition payment.
Virginia Resident Contributing to a VA 529 Plan:
Let’s say you live in Virginia and contribute $10,000 to the Virginia 529 College Savings Plan and then subsequently take out $10,000 in that same year to pay for private school:
- Virginia offers a $4,000 deduction towards your state taxable income per 529 account. So if you are in the roughly 5% VA tax bracket, you will have saved $200 for that year.
Illinois Resident Contributing to an IL 529 Plan
Contributions to an Illinois 529 plan of up to $10,000 per year by an individual, and up to $20,000 per year by a married couple filing jointly, are deductible in computing Illinois taxable income.
- So if I contribute $20,000 to a IL 529 plan, and either take $10,000 out to pay for K-12 expenses OR take $20,000 out to pay for college OR leave it in there to grow…I will receive a benefit of roughly $990 in tax savings (assuming a tax rate of 4.95%).
Some states provide more benefits than others, but regardless, it is a tuition payment savings!
For some, these amounts are negligible. For others, it is less money out of your pocket and you will take the financial wins where you can get them!
In Colorado, New Mexico, South Carolina, and West Virginia, in state 529 plan contributions are fully deductible to offset state taxable income. That could be a VERY significant tax savings depending on how much you contribute in that year and there is an argument to be had around front loading funds into these accounts sooner than later.
Before doing this, be sure your state 529 does not have contribution timeline restrictions on how long your funds need to be in the account in order to receive the state tax deduction. I only know of Montana and Wisconsin imposing a time limit on how long the funds need to be in the account for, but some others may as well.
Does This Make Sense For You? Things to Consider…
- Identify if your State 529 offers a state tax deduction for contributions
- Confirm that your state allows for the K-12 tax free distributions (most do)
- Are you currently paying for private school, college or a graduate program out of pocket? This strategy may be perfect for you to save each year while paying tuition payments.
The matter of the fact is that if you are seriously considering private school or college for your children – the 529 College Savings plan is hands down the most tax effective way to do so. There are limitations to the 529 Plan, but in my opinion there are far more long term benefits and opportunities than there are limitations.
Resources:
The Saving For College website is an incredible resource when trying to get specifics on each states 529 plan and their nuanced benefits.
Blog Post: What You Need to Know about 529 College Savings Plans
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