The recent tax bill expands 529 savings plans to include expenses for elementary and secondary education. And, the annual gift tax exclusion has increased. This is big news for education savers – no matter how much you are saving!
Congress wanted to make it easier to save for education. Traditionally, 529 plans have been used to cover college costs only, making 529 savings plans the go-to option to save for college for many families.
The new tax bill allows 529 plan distributions of up to $10,000 annually to pay for private school tuition all the way through the senior year of high school. This would include religious and parochial institutions.
“This expansion of the 529 plan is a net positive for families saving for higher education as it opens flexible options for tax-advantaged savings towards high school tuition as well.” said Peter Mazareas, a member and former chairman of the College Savings Foundation.
The other benefits of 529 plans remain unchanged. Earnings are accumulated tax-free each year, and distributions from the accounts for qualified educational expenses are also made free of tax. These tax-free savings and distributions help build a larger education savings nest egg and help reduce the amount borrowed for college.
States and national program managers offer 529 plans, often sold directly by the states (direct-sold plans) or through financial advisers (adviser-sold plans)
In addition to the federal tax benefits, you should also consider these factors:
State tax advantages: Many states offer deductions for qualified contributions. However, take a closer look at any restrictions. Some states require residents to use an in-state plan to qualify for deductions.
Fees and performance of investment options: As with any investment plan, it is important to pay attention to the fees and to the risk/return given the time frame for saving. Many plans offer age-based investment options to reduce the risk of principal loss as students get closer to college age.
More information on the program in your state can be found at SavingforCollege.com.
Some education savers may also take advantage of the increase in the annual gift tax exclusion. Taxpayers can now make tax-free gifts up to $15,000 ($30,000 for joint filers). If you have the means, consider taking advantage of a unique 529 plan benefit: you can lump-sum, super-fund a 529 plan with five years of gifting. Up to $75,000 can be bundled without gift taxes and put into a 529 plan, making it easy to transfer to relatives and help pay for future expenses. Once making the maximum bundled gift of $75,000, the contributor would have to wait five years before making additional gift contributions without penalty.
These changes are intended to encourage saving for education. But, the most important step remains the same: begin saving today. Consistently saving – even small amounts – over long periods of time allows a basic concept of finance, compounding, to work in your favor. Compound interest is the additional amount earned on previous interest. For example, if you have $100 in the bank and earn 3 percent interest, after 1 year you will have $103 if the interest compounds annually (aka simple interest). If it compounds every day, you will have $103.05. At the end of the second year, you will have $106.09 with annual compounding and $106.18 with daily compounding. The point is to illustrate that earning interest on interest grows savings as quickly as possible.
Another related basic rule of finance is that savings will double when the number of year times the interest rate approximately equals 70. For instance, in 10 years at a 7 percent interest, a $100 investment would be valued at $201.36, compounded daily. Taking advantage of compound interest can help grow education savings and reduce future college debt.
Finally saving for education is getting easier as crowd-funding opportunities are used. Many 529 plans have programs to permit relatives and friends to contribute to a student’s 529 education savings account. Also, be on the look-out for national programs such as Gift of College, which can now be found at retail outlets such as Toys R Us and Babies R Us. Friends and relatives can purchase these gift cards online or in stores to contribute to a student’s college savings.
All of these programs are designed to make saving for education easier with the hope of reducing future student debt. Remember: Saving a dollar today is better than borrowing one tomorrow.
To start a college savings account in Rhode Island, click here.