The cost of college tuition has risen dramatically over the past couple decades.
A 529 savings plan is the government’s way of helping families save for their children’s education with tax-free growth and withdrawals when funds are used as intended. Over the years, regular contributions and compounding earnings can provide significant funds toward educational expenses. Recent changes to the tax law included a provision for 529 plans that have the potential to impact many states and their residents, including Colorado. To help our clients, prospects and others understand the changes to 529 plans, Hanson & Co. has provided the key information below.
What Is a 529 Plan?
Originally created by Congress in 1996, a “qualified tuition program” was designed to encourage parents and other relatives to save for their beneficiary’s college education. Although contributions to 529 plans are not deductible on a U.S. tax return, the earnings are not currently taxable, nor will they be subject to tax when money is withdrawn, as long as the funds are all used to pay for qualified tuition expenses. Plans are generally managed by states and state agencies, and for families in 33 states, contributions to 529 plans are eligible for a deduction or credit on their state income tax returns. In Colorado, contributions into 529 plans are fully deductible, reducing state income tax.
2018 529 Plan Changes
Prior to the passage of the new tax reform law in December of 2017, the use of distributions from 529 plans was limited to qualified higher education expenses, such as college and other post-secondary training tuition, fees, books and room and board. Under the new law, parents also have the option to use 529 plan funds to pay tuition expenses for K-12 education at public, private, or religious schools. There is an annual limit though of $10,000 per beneficiary per year on withdrawals used for elementary and high school tuition. For state-run plans and states that allow a deduction or 529 plan contributions, this change could impact state budgets in an unintended way by potentially reducing tax revenue. Because 529 plan contributions in Colorado are fully deductible, participants could potentially fund their child’s entire private school tuition free from state tax.
Colorado State Legal Review
Despite the fact that funds won’t have much time to grow if taken out for early grades, some parents may be tempted to withdraw funds immediately to pay for elementary and high school expenses in light of the new federal law. However, the Colorado state tax treatment for K-12 expense withdrawals is currently under legal review. Funds withdrawn for K-12 tuition expenses could potentially be subject to state income tax recapture if the distributions are deemed ineligible under state law.
Before considering a 529 plan withdrawal for primary education expenses, it’s vital to consult with your advisor regarding your situation and the potential penalties for ineligible use of 529 plan funds. If you have questions about 529 plans or want to discuss a tax or other financial matter, Hanson & Co. can help. For additional information, please call us at (303) 388-1010 or click here to contact us. We look forward to speaking with you soon.