How I use a 529 to pay for my daughter's elementary school tution
My 9-year-old daughter Sophia is in 4th grade at a small catholic school in our Connecticut town. It's a nice school and has a small family like feel to it. But like any other religious or private school there is the tuition. Every quarter. This year I decided to try something different. I decided to make use of a recent change in the tax code and use a 529 plan to pay the bill. Recently the Tax Cut and Jobs act of 2017 expanded the use of 529 college savings plans to include K-12 tuition up to $10,000 per year per beneficiary. If this sounds overly complicated, consider the advantages.
The income tax advantages
Two big tax advantages to a 529 are money in a plan grows tax-free and withdraws are tax-free when used to pay qualified tuition like K-12 school up to the $10k limit per child. But the other advantage to using a 529 to pay for private K-12 school is the upfront state tax deduction. The state tax deduction means your contribution to the 529 plan is subtracted from your state income, which may help in reducing your state income tax. Not all states offer a tax deduction, but over 30 states offer a state income tax deduction or tax credit according to savingforcollege.com. Either way, if you're going to pay the tuition bill for a private elementary or religious school, why not take advantage of the state deduction and pay it with pre-(state) tax dollars?
Most states limit the state tax deduction to the first $5,000 of contributions ($10k for married couples) whether contributed for college or elementary school. If you are not meeting this cap, and need to pay the elementary school tuition, than you can contribute to your state's 529 plan to help max out your state deduction.
Here's what I learned
Though I am contributing to 529 accounts, one for each of my three kids, those monies are earmarked for college. I didn't want to withdraw those monies for elementary school. I thought about commingling accounts, and contributing to my daughter's already established 529 college savings account, this way I wouldn't have to open a new account. Then I learned the withdrawal would be a problem.
When you go to take money out of a 529, you can't designate which money comes out first, the recent contribution or the contributions from a long time ago. The way it works is some of the withdraw is principal and some of it is earnings. Meaning if I commingled elementary catholic school tuition money with college savings money, when I go to withdraw the elementary school tuition money to pay the bill some of the earnings (from the college money that was in the account for a long time) will have to come out too! Granted those earnings are tax-free because K-12 tuition is a qualified expense, I didn't like that approach for the simple reason I didn't want to sell a mutual fund that was performing well. I wanted to leave the college money alone and let it continue to grow. I had to go down a different path.
I tried opening a separate 529 account for my daughter with the same vendor. This account would house only the elementary school tuition money, but that didn't fly. Apparently, our state's 529 vendor doesn't allow one owner to have two 529 accounts for the same child or beneficiary. Yet again, it was time to try another approach. This time I had my wife open a 529 with the same vendor for my daughter. This we could do. Now I have little bits of money going from my checking account into the 529 that my wife owns to be used for when the tuition bill comes. But when I went to take the money out to pay for my daughter's tuition, I ran into another roadblock.
The vendor's website wouldn't let me make the withdraw! Apparently, contributions need to be in the account for 30 days. Luckily, I was able to scramble and pay the bill with other money, but this was yet another wrinkle. At least now I have next quarter's bill ready to go from my wife's 529 account. Going forward, if I keep this up, and that's a big if, I will have to make sure all contributions to my wife's 529 account are made at least 30 days prior to needing to make the withdraw.
The benefits are twofold. First, the contributions to the 529 earmarked for my daughter's elementary tuition are in a safe reliable high-interest bearing account. This means that the interest is compounding tax-free – albeit very little since the time frame is short. Still this is better than having it sit in a taxable checking account. Secondly, I am able to max out my state's tax deduction. Currently, I have a 529 with a separate state earmarked for college, because I like the mutual fund selection with that plan. That plan is invested in a more aggressive age-based target date fund. The 529 for elementary school is through my home state of Connecticut, and invested in a more conservative stable value option. Contributions to that account are eligible for the state tax deduction.
All in all, it may take a little bit more work to use a 529 to pay for elementary school, but this extra work can be rewarded with tax-free earnings and if your state offers it, a state tax deduction that can lower your state income taxes. It's best to check with your state about how their deduction works. Given how much elementary, high school, and college tuition costs, parents need all the help they can get.
What do you think? Have you tried paying K-12 tuition with your state's 529? If so, what is your experience? Email me your thoughts: email@example.com.