Editor’s Note: This blog has been updated as of February 14, 2022 for accuracy and comprehensiveness.

The Tax Cuts and Jobs Act (TCJA) made three notable changes to Section 529 plans, including a new provision allowing you to withdraw (tax-free) up to $10,000 per year to pay for elementary and high school tuition. The SECURE Act further expanded the benefits of these plans, starting in 2019. In addition, some parents have decided to contribute advance child tax credits received in 2021 to these plans. Read on for more details.

1. Funds May Be Used for Elementary and High School Tuition

For tax years starting in 2018, you can withdraw up to $10,000 per year to pay for tuition at a public, private, or religious elementary or secondary school. (The provision applies on a per-student basis, rather than a per-account basis.) These withdrawals are federal-income-tax-free. And, unlike many of the individual tax provisions under the TCJA, this change is permanent.

There are a couple of caveats to consider. First, Sec. 529 plans are state run. So, it’s possible that some states may not allow tax-free distributions to attend a school with a religious affiliation.

Second, the expanded use of Sec. 529 plans could cause disputes between divorced parents. How? If a noncustodial parent is responsible for paying for college costs and has been contributing to a Sec. 529 plan, he or she might be unhappy to discover that the custodial parent took distributions from the account to cover tuition costs for elementary or high school, without first discussing the withdrawals with the noncustodial parent.

2. Large Contributions Reduce Your Lifetime Exemption

In general, contributions to Sec. 529 plans are limited to your annual gift tax exclusion ($16,000 for 2022, or $32,000 if you are married and make a joint contribution with your spouse).

However, under the TCJA, for tax years starting in 2018, a special break allows you to front-load five years’ worth of annual exclusion gifts per beneficiary. So, for 2022, you could “jumpstart” a Sec. 529 plan account by contributing up to $80,000 (or $160,000 if you are married and make a joint contribution with your spouse). Contributions above that amount will use up part of your unified federal gift and estate tax exemption.

Another provision of the TCJA increased the lifetime exemption for 2022 to $12.06 million if you’re single or $24.12 million if you’re married. So, the reduction for jumpstarting a Sec. 529 plan is probably not a major concern for most people. But the TCJA provision that expands the lifetime exemption is set to expire in 2026.

3. Funds Can Be Transferred to ABLE Accounts

If you have a child who became disabled before age 26, you can set up a tax-favored Achieving a Better Life Experience (ABLE) account to cover qualified disability expenses. Like Sec. 529 plans, contributions to ABLE accounts aren’t tax deductible, but distributions are tax-free if they’re used to pay for housing, education, health care and other qualified expenses for a designated beneficiary.

Under the TCJA, funds now may be rolled into an ABLE account, tax-free, from the designated beneficiary’s own Sec. 529 plan or from the Sec. 529 plan of certain family members. Rolled-over amounts count toward the overall limitation on amounts that can be contributed to an ABLE account within a taxable year.

SECURE Act Enhancements

The SECURE Act further expanded the benefits of Sec. 529 plans. Specifically, it allows federal-income-tax-free account distributions made after December 31, 2018, to cover:

• Costs associated with registered apprenticeships, and
• Up to $10,000 of qualified student loan principal or interest payments per beneficiary.

Important: The limited deduction for student loan interest allowed by Internal Revenue Code Section 221 is disallowed to the extent the interest was paid with a tax-free Sec. 529 account distribution.

Additional Saving Opportunity

Under the American Rescue Plan Act (ARPA), eligible families received advance payments for the expanded child tax credit in July 2021 through December 2021. Some parents who were eligible for advance child tax credit payments — but didn’t need the cash to pay for childcare costs — have used the extra money to start a Sec. 529 plan or add to an existing one.

For eligible families, these payments equaled up to:

• $300 a month for each child under age 6, or
• $250 a month for each child age 6 through 17.

(Advance payments are phased out at higher income levels.)

For example, an eligible taxpayer with a 10-year-old child would have received up to $1,500 in advance payments in 2021 ($125 × 6 months). That’s a sizable chunk to contribute toward a child’s future education costs.

If you didn’t contribute advance payments to a Sec. 529 plan last year, consider doing so now — before you spend the extra money on a vacation or a gaming system that your kids will outgrow.

Also remember that the advance payments are only half of the expanded credit that will be given to eligible families; the other half will be credited toward your tax obligation when you file your 2021 tax return. So, you may want to make another contribution to your child’s Sec. 529 plan when you file your tax return.

If you didn’t receive advance payments but meet the eligibility requirements, you’ll benefit from the full expanded credit when you file your 2021 tax return in April.

Beware: If you receive excess child tax credit payments over what you actually qualify for in 2021, you’ll be required to repay the excess when you file your tax return for 2021.

The future of the expanded child tax credit is uncertain. The ARPA changes, including monthly advance payments of the credit, were available only for 2021, unless Congress passes legislation to extend them. So, this strategy may be a limited-time opportunity.

Need Help?

Our tax professionals can help you understand the changes to Sec. 529 accounts under the new law and brainstorm tax-savvy ways to make your family’s education more affordable. Contact us for more information.