Tax reform enhances college savings plans

The Tax Cuts and Jobs Act resulted in the largest overhaul to the tax system in 30 years, including some key changes to 529 accounts. As year-end approaches, it is important to know what has changed for planning ahead.

The current advantages of 529 college savings remain the same, including tax-free withdrawals for qualified college expenses — tuition, room and board, supplies, computers, and WIFI — at an accredited post-secondary institution.

529 plans were enhanced under tax reform

Several provisions were added, and some definitions were enhanced, under the 2018 tax law.

Tax-free withdrawals for K–12 tuition

Tax reform broadened the definition of a qualified distribution, to include up to $10,000 per year per student for tuition at an elementary or secondary public, private, or religious school (K–12). For tax purposes, “tax-free withdrawals” refers to federal taxes. State laws may differ.

Currently:

• 36 states allow K–12 as a qualified distribution for state tax purposes
• 9 states do not consider distributions for K–12 tuition expenses to be a qualified withdrawal (state income taxes may apply on distributions)
• 4 states are not clear, or a decision is pending
• 2 states have pending legislation

Investors should consult a financial advisor and tax professional to verify the information about their local laws (or the laws of the state where the beneficiary resides).

Tax-free transfer to an ABLE account

Families may now direct rollovers from a 529 savings plan to an account established for the beneficiary of a “qualified ABLE program.” ABLE (A Better Life Experience) accounts were created in 2014 to serve as investment vehicles, designed like a 529 plan, for individuals with disabilities.

This is how the provision works:

• Rollover distributions must be made after December 22, 2017, and prior to January 1, 2026
• Rollovers must be completed within 60 days of the withdrawal
• The recipient account must benefit (1) a different individual who is a “member of the family” of the beneficiary of the account from which the transfer is being made, or (2) the beneficiary of the account from which the transfer is being made
• The distribution is subject to the annual limitations on contributions from all sources

A financial advisor or the plan administrator can provide more information about how to make the transfer.

Reinstate contributions tax free

There are instances when a family may want to reinvest a distribution. For example, if the student receives a tuition credit, families can contribute the amount back into the 529 plan within 60 days of receiving the payment without any tax consequences.

Key year-end reminders

The annual gifting limit increased in 2018 to $15,000 for individuals per year, up from $14,000 in 2017. This means that a couple can contribute up to $30,000 per year for each beneficiary. In addition, a special provision of 529 plans allows individuals to contribute up to five year’s worth of gifts in one year. The new gifting limits allow for $75,000 for an individual ($150,000 for a couple) per beneficiary.

• Investment exchanges are allowed twice per calendar year. Year-end is an opportune time to review investment options and allocations to make sure your plan is on track.
• For families currently paying tuition, it is important to take a federal tax-free distribution from a 529 plan account in the same tax year that the qualified expense occurred. For more information, refer to our post, “Next steps when the first college bill is due.”
• For the holiday gift-giving season, consider establishing a 529 plan and inviting family and friends to make a gift of education.

For additional ideas and resources to help meet education savings goals, explore Putnam’s investor education articles, “Early college planning for a growing family,” “Four-year action plan for high school students,” and “Strategies to make the most of college savings.”

 More ideas for wealth management at Putnam.com

The opinions expressed here are my own and not those of Putnam Investments and are not intended as tax, legal, or investment advice. Investors should carefully consider the investment objectives, risks, charges, and expenses of a fund before investing. For a prospectus, or a summary prospectus if available, containing this and other information for any Putnam fund or product, visit the prospectus section, call your financial representative, or call Putnam at 1-800-225-1581. Please read the prospectus carefully before investing. Putnam Retail Management

314936