529 for K-12

[MFM DOC]

I was discussing 529s for K-12 with a colleague whose kids are in private school.  We were discussing the feasibility/ability to put money into the 529, draw it out a day/week/month later for tuition purposes, then get the tax deduction for state income tax.

It seems the amendment to allow using 529 funds for K-12 was introduced by Ted Cruz, but since Texas has no state income tax this change won't affect his state.  But in states where state income tax deductions are possible the states are going to lose (significant?) tax revenue.  Some states limit the amount able to be deducted, but some don't (South Carolina, West Virginia, New Mexico).

https://www.npr.org/sections/ed/2018/01/08/575167214/congress-changed-529-college-savings-plans-and-now-states-are-nervous

Anyone planning on doing this?  It would seem surprising if the states (especially the ones that have no maximum deduction) didn't adjust their tax laws accordingly.

[Ryan]

This is called using the 529 as a "pass-through" has been done for some time in states giving deductions and credits. Some states have differing requirements of holding periods, others have no requirements at allt. You're right in suggesting that state tax laws may be adjusted to reduce the benefit now that its use will be much more widespread. Mostly, it's an enormous tax benefit for private school tuition.

[boogiba]

I have been trying to rationalize the benefits to using a 529 for private K-12 eduction as well. I live in Michigan, where contributions up to $10k are deductible from state income tax. I am already contributing up to deductible limit with the intent to use for college expenses, so any additional contributions for K-12 expenses would not be deductible. The returns on the contributions would still be sheltered from federal and state income tax, but it seems like the age old advice to not invest money you may need in the next year rules in this case.

I suppose that one might be able to realize enough tax sheltered capital gains over 5-10 years to make it worth the effort for paying for private high school expenses, assuming that your kids like mine are just starting their K-12 education. The biggest beneficiaries seem to be individuals who were not maximizing their contributions to their 529 plans, but were also paying for private education. In that case, in a state with income tax and a deduction available, it is a no brainer.

I have 4 kids, so maybe it does make sense for me to start contributing above the $10k deductible limit. If the account values appear to be greater than what would be anticipated for college expenses, then I could use them for private high school expenses and take advantage of what will hopefully be a large sum of tax sheltered gains on the contributions. You could also invest in a safer 529 investment option so you don't worry about a decrease in your principle contribution amount, but then the benefits may not outweigh the drawbacks.

Any other suggestions?

[MPMD]

Lot's of fuss and trouble to save a few hundred bucks.

IL max for state tax break is $20k so by following this strategy I'd save $1k/year in state taxes. Might be worth it or might not.

The biggest value in this I could see is for people who are able to really super-fund their 529 like throw in $300k before the kid is 5 and then use some of the growth to pay private school in jr high/HS. I think that's where I am with my plan for the next few years which is going to be to try to turbo-charge 529 rather than extra-taxable or mortgage payments.

[MFM DOC]

It seems likes it's going to be very state dependent on whether it's worth the time and effort.  Here is the Vanguard calculator:

https://vanguard.wealthmsi.com/stdc.php

For example in South Carolina, MFJ with a taxable income of 300k, if you contribute 40k the total net tax savings is $2,128.  If your kids are in private school (or college for that matter) why not use the "pass-through"?  Seems worth it everything else being equal.  The new law just seems to make it apply to many more students since the 529 can be used for K-12 expenses.

[MFM DOC]

MPMD wrote

The biggest value in this I could see is for people who are able to really super-fund their 529 like throw in $300k before the kid is 5 and then use some of the growth to pay private school in jr high/HS. I think that’s where I am with my plan for the next few years which is going to be to try to turbo-charge 529 rather than extra-taxable or mortgage payments.

Click to expand...

I totally agree if the plan is to go the private school route

[MFM DOC]

boogiba wrote:

The biggest beneficiaries seem to be individuals who were not maximizing their contributions to their 529 plans, but were also paying for private education. In that case, in a state with income tax and a deduction available, it is a no brainer.

Click to expand...

This is what I was thinking/discussing with my colleague - using the pass-through for K-12 expenses.

 

[Hank]

I'm still targeting four years of undergrad for each of the kids as the primary use of our 529s.  However, if private school is a better fit than public school for one or more of the kids, I would run $10K through the 529 each year for the tax benefits until the states patch this hole in their budgets.

If you're in a position to contribute a large amount to the 529 while your kids are quite young, you might want to do so.  If you end up with more than they can use for undergrad, you still could use the funds for grad school, professional school, education for nieces and nephews, or back to school for you when you go part time or retire.

Just make sure that you prioritize more than sufficient funding for your own retirement before you start funding the 529 beyond the amount allowable for state tax credits or deductions.  Likewise, don't pay for private K-12 if you aren't already on track for more than sufficient retirement savings.

[MPMD]

The thing is when you pass it through you're getting a small state tax break but missing out on the tax free growth that seems to be almost the whole point of the account.

[Hank]

MPMD wrote:

The thing is when you pass it through you’re getting a small state tax break but missing out on the tax free growth that seems to be almost the whole point of the account.

Click to expand...

True.  However, if you were saving for college with the 529 today while also cash flowing the cost of private school tuition, it makes perfect sense to run at least $10K more per kid through the 529 before cutting a check to the private school.

[Medikit]

The answer to this problem for most states will be to just kill the state income tax incentive.

[Tabaxus]

Medikit wrote:

The answer to this problem for most states will be to just kill the state income tax incentive.

Click to expand...

Although states that do this are likely to see their participation rates crater, unless they are one of the handful of states that actually has good options.  NY, Utah, Illinois don't seem terrible.

 

The state I'm in has a deduction up to $10k ($20k for married couples).  Unfortunately, because I get taxed in multiple states, I get a pretty small benefit from the state tax deduction because of the way the tax credit for taxes paid in other states works.  So I have to balance a pretty small state tax benefit against nominally higher fees and I think the fees are going to win.  That's made even more true since my state doesn't permit you to take the deduction for the excess amount in later years if you do the pre-funding under the 5-year rule.

I think it's the case that the $150k cap for 5-year funding isn't even really a cap, by the way.  That's just the maximum amount you can do without chewing into the gift tax/estate tax exemption.  Given the tax-free growth, I'm honestly considering overfunding even beyond the 5-year gift tax maximum and just taking the hit on estate tax later, when (a) I will be dead and (b) if my estate is subject to estate tax, well, whomever is getting my estate is obviously getting more than enough anyway.