Section 529 plans

Sec. 529 savings plans

The benefit? Amounts can grow tax-deferred and distributions typically aren’t taxed, so long as a few requirements are met. For starters, the money must be used to cover qualified educational expenses for the beneficiary. Keep in mind that, though contributions to a 529 plan aren’t deductible for federal purposes, many states offer deductions or other tax incentives.

Through 2017, only postsecondary education expenses qualified. With the passage of the Tax Cuts and Jobs Act, tuition at elementary or secondary schools also may qualify, subject to a $10,000 per student per year limit.

For postsecondary education, qualified expenses include not only tuition, but also required fees, computer technology, books and, generally, room and board.

Another requirement for tax-free distributions is that the beneficiary be enrolled at or attend an eligible educational institution. This now includes public, private or religious schools that provide elementary or secondary education. Eligible postsecondary schools generally are accredited public, nonprofit or private colleges, universities, vocational schools or other postsecondary educational institutions.

Contributions to 529 plans are limited to the extent that they can’t exceed the amount necessary to provide for the beneficiary’s qualified educational expenses, but there’s no specific dollar-amount cutoff under federal law.

Investment options for 529 plans typically include equity and fixed income funds, as well as money market and real estate funds. Some plans offer age-based portfolios that shift to more conservative investments as the beneficiary approaches college age. Another option, a target-risk portfolio, tries to maintain a specific level of risk.

ESAs

An ESA is a trust or custodial account established to save for the education expenses of a beneficiary, who must be under 18 or be a special-needs beneficiary. To contribute to an ESA, your modified adjusted gross income (MAGI) for 2018 must be below $110,000, or $220,000 for married couples filing jointly.

Contributions are limited to $2,000 annually per beneficiary. To make the maximum contribution, your MAGI must be no more than $95,000 or $190,000, respectively.

While ESA contributions aren’t tax deductible, the amounts in the accounts can grow tax-free. Distributions are tax-free when used to pay qualified education expenses, such as tuition, fees and books, at eligible elementary, secondary or postsecondary schools.

With the passage of the Tax Cuts and Jobs Act of 2017, both ESAs and 529 plans can be used to cover elementary and secondary tuition; previously, only ESAs could cover this expense. However, ESAs also can be used to cover books, supplies, tutoring and some other elementary and secondary education expenses.

Another potential ESA advantage over 529 plans is more investment choices. But that might not make up for the lower contribution limits.

Complex rules

The rules surrounding college savings options can become complex; additional rules apply beyond what we’ve discussed here. And while these plans can help save taxes, keep in mind that money in the account that’s not used for qualified educational expenses may be subject to taxes and penalties.

Your accounting professional can help you determine the best ways for you to save for your own or your child’s ― or grandchild’s — education.

Sidebar: Student loan deduction survives tax reform

An earlier version of the Tax Cuts and Jobs Act (TCJA) had included the elimination of the student loan interest deduction. But the final version of the TCJA that was signed into law retained this valuable tax break.

This means that, if your 2018 modified adjusted gross income doesn’t exceed $65,000, or, if married filing jointly, $135,000, you may be able to deduct up to $2,500 of student loan interest when you file your income tax return next year. A partial deduction is available for MAGIs that exceed these amounts but are below $80,000 or $165,000, respectively.

Note that $2,500 is a per- return limit. So if, say, you and your spouse each have $2,500 of student loan interest and you file a joint return, you’ll be able to deduct only $2,500 of that interest. And you can’t get around this rule by filing separately; separate filers aren’t eligible for the student loan interest deduction.

The TCJA also helps taxpayers with student loan debt in certain circumstances. Specifically, student loans discharged after December 31, 2017, because of a student’s disability or death are excluded from the taxpayer’s income.

© 2018