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The tax advantages of establishing a 529 account now apply to expenses incurred by private elementary school. Knowing the benefits is important to saving money on a lifetime of education.
Establishing a 529 plan as soon as possible will allow the accumulation of tax-free investment gains.
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 incurred from private elementary and secondary schools, including parochial schools.
Effective this year, federal rules permit the use of these plans, called 529 plans, twelve 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 offer tax deductions, with some even offering tax credits, on the money put into them. And 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 some 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 have been making substantial contributions to a 529 in recent years. 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. When your child enters school, you withdraw $10,000 a year, the maximum allowable pre-college withdrawal per child per year, toward tuition, room-and-board and other qualified expenses associated with your child’s private school enrollment. Qualified expenses also include books, software and equipment, according to Capital Accounting Group in Phoenix, AZ. By making these $10,000 withdrawals from a 529 plan to pay for grades one through twelve, you avoid having to pay nearly $2,500 per year 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% a year from gains on investments within it, you’ll have more than $370,000 left for college without making any contributions beyond the initial $200,000. The example assumes all the money will be used for education purpose as IRS rules limit contributions to the amount necessary to pay qualified expenses. Depending on how much your eldest child’s college education costs, you could 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 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 by their home state. Like 401(k) plans, these plans can vary considerably in investment options, fees and potential returns. A key reason for this is that states choose different financial institutions to hold their plans.
With all the potentional tax advantages, it is a good idea to shop around the country for the best 529 options. Look for plans in states that enable a tax deduction on contributions in your home state and also offer the best potential returns. State-by-state information can be found on the website, savingforcollege.com.
These plans are not limited to paying for elementary and college education costs for your children but could also be allocated to extended family, including nieces, nephews and grandchildren. Even your own education expenses, should you choose to go back to school, could be funded by monies left in a 529 account. Therefore, if one of your children gets a scholarship, you can — and should – allocate unused 529 funds to pay for education expenses of other family members.
So if you have children headed for private elementary or secondary school and do not currently hold a 529 plan, the windfall provided by the new rules makes it time to consider one. Even if you plan on utilizing the public school system for your child's elementary education, establishing a 529 plan as soon as possible will allow the accumulation of tax-free investment gains.
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.
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