In response to provisions included in the U.S. Congress’s federal budget bill, passed into law in December, the North Carolina General Assembly has expanded the state’s qualified tuition plan, also known as a 529 plan, to families saving for private K-12 educational needs. The new provisions governing 529 usage were included in the recently passed state budget. The budget bill was vetoed by Governor Roy Cooper. However, both houses of the state legislature voted to override Gov. Cooper’s veto. Accordingly, the new law takes effect on July 1, 2018.
In 1996, Congress created 529 plans, known by their section of the tax code enforced by the Internal Revenue Service. Within 529 plans, there are two basic types: prepaid tuition plans, which are typically run by universities like those in the University of North Carolina System, and education savings plans.
Historically, families used 529 education savings plans to save for qualified college expenses (tuition, mandatory fees, and room and board) with tax-free investment growth. In December, Congress reformed these plans to allow for the expansion of federal capital gains tax exemption to include money saved and spent on qualified K-12 private school expenses. With its action within the state budget this June, the NCGA has joined Congress, effectively waiving state taxation on investment gains in NC 529 accounts, as long as the monies are applied to either college or K-12 qualified expenses.
It’s important to note that unlike other deductible savings plan contributions like those in traditional individual retirement accounts, contributions to 529 education savings plans are not deductible at federal or state level, even under the new rules.
With tuition alone at North Carolina’s most expensive private schools averaging more than $20,000 annually, the new expansion of 529s is a boon to parents and grandparents of private schoolchildren statewide. Before you think you can start dumping money in these accounts to take care of all of your family’s education needs and do so with tax-free growth, it’s important to know your limits. And limits are a little trickier with 529s, because the government doesn’t directly prescribe an annual contribution limit as with retirement accounts. Previously, investors looking for tax preference on education costs prior to college had to use other account types such as Coverdell Education Accounts. Those accounts will still be available, but they have disadvantages to 529s, including much lower contribution limits.
For both financial planning and estate planning considerations, you need to remember that these types of accounts are considered gifts in the mind of the IRS and thus fall under gift rules in the tax code, with some qualifications for these accounts. In 2018, the amount of a gift must be at or below $15,000 to avoid taxation. However, you can give multiple gifts of $15,000 or less to as many different individual recipients as you wish. For example, suppose you have three adult children and seven grandchildren, you could give $15,000 to each recipient for a total of $150,000 excluded from gift taxation. You can also give a lump sum, not to exceed $75,000, and use a five-year election, where you’re “spreading” the amount of the gift over the current tax year and the next four, as if you gave the money in $15,000 increments.
In addition, if you gift an amount that’s above the annual gift tax exclusion, you can also tap into the lifetime estate and gift tax exemption. The lifetime exemption effectively shelters from tax $5 million, indexed for inflation. The inflation-indexed amount for 2018 is $5.6 million per individual (and $11.2 million per couple, by extension). Be aware, however, if you tap into the lifetime gift tax exemption, it erodes the estate tax exemption amount that would be available when you die. Keep in mind, too, that the government, at any level, won’t let you shield millions of dollars in 529s—the savings must be in line with reasonable college and K-12 expenses in your area.
With all that being said regarding tax advantages of a 529 plan, you are probably asking, “What does the new law actually allow me to do with the money I invest in a 529 plan?” The expanded uses for 529 dollars, while much more flexible, are not limitless. Distributions from 529 plans are capped at $10,000 (yearly) saved in 529 accounts to pay for tuition for children attending kindergarten through 12th grade. At present, tuition and fees are the only qualified expenses for 529 withdrawals for K-12 spending. So, books and supplies, computers, room and board, and special needs equipment for K-12 are not qualified expenses, though they may be for college education expenses. It is important to remember that for funds that are used for non-qualified expenses, you will have to pay taxes plus a 10% penalty on any earnings – not original contributions – you withdraw.
Currently, North Carolina’s 529 has more than $2.3 billion invested across nearly 140,000 individual accounts. Expect these numbers to grow in a big way, as attorneys and financial professionals begin meeting with clients in the wake of the 529 expansion to K-12 costs. If you need help planning to protect your assets, limit your taxation, and provide for your children’s educational future, we are ready to help you at the Forrest Firm. Contact us today to get started.