By Robert DeHollander
CFP®, AIF®, CRPC®, managing principal, DeHollander & Janse Financial Group
Are you a parent or grandparent of a child attending private school? If so, I have good news for you. With the new tax bill, parents who send their kids to private elementary, middle, and high school will have more options when it comes to saving and paying for tuition. Previously, the primary vehicle that offered tax-free growth for K-12 was the Coverdell Education Savings Account (ESA). I have ESAs for my kids, and they’re pretty cumbersome. The contribution amounts are low, and they’re subject to earned income phaseout limits. Enter the recent tax law changes and the South Carolina Future Scholar 529 College Savings Plan.
529 PLAN AND THE COVERDELL ESA: Originally designed to help families pay for college — not K-12 — 529 college savings plans are tax-advantaged investment accounts. The earlier you started saving, the greater the benefit from tax-free compounding. Currently, 529 withdrawals are tax-free as long as the funds are spent on qualified higher education expenses, which include tuition, room and board, and computer software and equipment at any eligible post-secondary institution. This part isn’t changing, but the new tax law now allows funds from 529 savings plans to pay for K-12 tuition.
With a shorter time horizon, you might not see much of a compounding benefit from using a 529 to pay for elementary or middle school tuition. However, you may be eligible for a state tax break if both you and the student are South Carolina residents. Currently, South Carolina offers residents an unlimited state tax deduction for contributions to their 529 plans. Nationally, the amount of the potential benefit varies by state, but South Carolina’s is one of the best in the country. There are two possible benefits — an immediate state tax deduction for new contributions and a possible long-term tax savings from growth of the underlying investments.
HOW DOES THIS WORK? Here’s the strategy: Assume you’re paying tuition directly to a private school (i.e. Southside Christian, Christ Church, Bob Jones Academy, etc.). Right now, you probably receive no tax relief — you simply use after-tax dollars to pay the tuition bill. Under the new tax law, you can do two things: 1. Use your existing 529 funds to cover a portion of your tuition (up to $10,000 per year) with tax-deferred savings; and 2. Put new savings in the South Carolina 529 (the money you’re paying for tuition), then withdraw and use these funds for private tuition (contributions must be in the plan at least 10 days), earning a nice state tax break. Finally, a caveat: This works best for annual tuition dollars. Be careful not to raid your existing college savings simply for a tax break. A good financial adviser can help you run the numbers and determine what makes sense.
WHAT ARE THE HIGHLIGHTS? In summary, here are a few highlights of the tax law changes as they relate to the South Carolina 529 plan:
- The Tax Cuts and Jobs Act, which was signed into law in December, allows families to use 529 plans to pay for up to $10,000 in tuition expenses at elementary or secondary public, private, or parochial schools. The changes became effective Jan. 1.
- Although not all states have adopted it, South Carolina has, and qualified distributions from South Carolina and non-South Carolina 529 plans are exempt from taxes.
- The final tax reform bill did not allow 529 plans to be used for homeschooling expenses.
- Contributions can be made up to April 15 for the 2017 tax year.
- There is no age or income limit to set up a South Carolina Future Scholar 529 plan.
- Within the South Carolina Future Scholar 529 Plan, you must leave the contributions in your account for at least 10 days, then allow up to two weeks for processing any transfers to an institution.
Robert DeHollander is a managing partner and co-founder of the DeHollander & Janse Financial Group in Greenville.