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Client Conversations: Thanks Tax Reform! A Smart Way to Save for Education Just Got Smarter.

February 2018

There has never been a better time to educate yourself about 529 plans, between expanded flexibility and increased tax advantages.

Client Conversations gives financial advisors an easy way to communicate with clients on topics influencing financial markets; it highlights common investor behaviors and offers ways to address the challenges investors face. Share this article with your clients, and remember to follow your firm's policies that govern sharing content with clients and prospects.


Until this year, When was the last time the US tax code had seen a major overhaul? Forget Black Mirror and Game of Thrones, the water cooler talk was all about whether you’d gotten the chance to catch the latest episode of Cheers and what songs were on the mix tape you’d made for your commute.

That’s right, it’s been more than 30 years—1986—since the US tax code changed this dramatically. This time, one particular aspect of the reform has sent some people into a tizzy. In the past, individuals have been able to claim all state and local taxes as deductible at the federal level. Now, thanks to the Tax Cuts and Jobs Act, effective January 1, 2018, there is a deduction limit of $10,000.

Some states, particularly those with high tax rates, are scrambling to think of ways to help their residents keep their state and local taxes below $10,000 to avoid any additional tax burden. In California, a bill has been introduced encouraging residents to pay some of their state taxes to a state charity called the California Excellence Fund.1 In Maryland, legislators have plans to enact bills allowing for charitable contributions to public schools.

But there may be another smart and simple solution for those seeking to lessen their tax burden that doesn’t require political action (or red tape): 529 plans.

 

A what plan?

If you don’t know what a 529 plan is, you’re not alone. Since their inception in 1996, 529s have been one of the best ways to save for college, but they’re still underused. Only 37% of parents saving for college take advantage of them.2 Parents who save for education other ways explain that either they don’t know what 529 plans are or they don’t understand enough about them to open one.

So, let’s break it down—what are 529 plans? They’re state-sponsored, tax-advantaged savings accounts that grow tax free. Investments within a 529 plan range from aggressive to conservative. And there are even age-based portfolios, which become increasingly conservative by allocating more to fixed income as the beneficiary nears college age. Of course, as with any investment, returns are not guaranteed, and you could lose money by investing in a 529 plan. Fees and expenses vary by state, as do tax advantages, but all around they’re an excellent way to save for education expenses.

These plans are also flexible. Funds from a 529 plan have historically been applicable to all qualified post-secondary education expenses, namely college tuition, room and board, books, supplies, etc. Additionally, if your child gets a scholarship or decides not to pursue higher education, you have the flexibility to transfer the 529 plan to someone else, including yourself. That’s right, you can set up a 529 plan for yourself—so no kids, no problem. Anyone can save for education with a 529 plan.

Whether you already know about the savings potential of 529 plans or not, you may not know that there have been some significant changes to the plans as part of the recent tax overhaul.

Now, 529 plans are even more flexible, applying to a wider range of education expenses. And with the passage of the new tax legislation, on top of being a good way to finance your child’s education, they have the potential to counteract negative tax consequences stemming from the new limit on state and local tax deductions.

 

Increasing Flexibility

In the past, funds from 529 plans could be applied only to qualified post-secondary education expenses. While the definition of education expenses was broad, the money had to be used for post-secondary school, whether that be a 2-year college, culinary or technical school, a 4-year undergrad program, or some other kind of education beyond high school.

Now, as a result of the recent tax overhaul, up to $10,000 per student can be withdrawn annually to pay for private K-12 education. That’s right, 529 plans aren’t just for college anymore. The already flexible 529 can be used for more now than ever.

 

Getting down to business

Flexibility of expenses is an incredible feature of a 529 plan, sure, but let’s talk turkey (i.e., taxes).

At the federal level, 529 plans are attractive because they’re funded with after-tax dollars, interest compounds tax free, and funds (for qualified expenses) can be withdrawn without being taxed.3

At the state level, tax advantages vary from state to state and from plan to plan. More than 30 states offer tax deductions or credits on contributions to 529 plans at the state level,4 though this is nothing new.

What is new is how just how meaningful the deductibility of a 529 plan is. Contributions to 529 plans qualify as deductible at the state level on top of the new $10,000 limit on state and local tax deductions.5 So, parents can use 529 contributions to offset the new limit. In high-tax states, such as Connecticut or New York, this is something to be excited about.

These tax incentives generously apply to investments of up to, generally, $15,000 per year per student (after that, contributions are subject to gift tax).Lifetime maximum contributions to 529 plans vary by state but are at least $250,000 per beneficiary, generally.

In short, there has never been a better time to educate yourself about 529 plans, between expanded flexibility and increased tax advantages.

 

Next steps

If you don’t have a 529 plan (yet), talk to your financial advisor to determine whether opening a 529 might be a smart option for you and your family. If you do, get excited, but do your due diligence. Before you rush to cash in 529 funds to pay for pricey private kindergartens, consider the immediate benefits versus the benefits of long-term, tax-free compounding. Your advisor can help you establish the right plan for you, given your state, plan, tax level, and circumstances.

It’s been a long time since the tax code has been changed so dramatically, and investors will need to adjust and plan differently for the year ahead. But just as we’ve progressed from VCRs and cassette tapes to a streaming world of Netflix and Spotify, we must adapt to this new tax code. And 529 plans might just be a smart place to start.

 

What does your state offer?

STATE TAX BENEFITS
Alabama Contributions to an Alabama 529 plan of up to $5,000 per year (individual) and $10,000 per year (married filing jointly) are deductible in computing Alabama taxable income
Alaska Alaska does not have a personal income tax
Arizona Contributions to Arizona AND non-Arizona 529 plans of up to $2,000 per year (individual) and $4,000 per year (married filing jointly) are deductible in computing Arizona taxable income
Arkansas Contributions to an Arkansas 529 plan of up to $5,000 per year (individual) and $10,000 per year (married filing jointly) are deductible in computing Arkansas taxable income. Contributions to a NON-Arkansas plan of up to $3,000 per year by an individual, and up to $6,000 per year by a married couple filing jointly, are deductible.
California No state income tax deduction for contributions to 529 plans
Colorado Contributions to a Colorado 529 plan, to the extent of the contributor's federal taxable income, are deductible in computing Colorado taxable income
Connecticut Contributions to a Connecticut 529 plan of up to $5,000 per year (individual) and $10,000 per year (married filing jointly) are deductible in computing Connecticut taxable income, with a five-year carryforward of excess contributions.
Delaware No state income tax deduction for contributions to 529 plans
District of Columbia Contributions to a District of Columbia 529 plan of up to $4,000 per year (individual) and $8,000 per year (married filing jointly) are deductible in computing District of Columbia taxable income, with a five-year carryforward of excess contributions. Only contributions made by the account owner are deductible.
Florida Florida does not have a personal income tax
Georgia Contributions to the Georgia 529 plan of up to $2,000 per beneficiary per year (individual) and $4,000 per year per beneficiary (married filing jointly) are deductible in computing Georgia taxable income.
Hawaii No state income tax deduction for contributions to 529 plans
Idaho Contributions to an Idado 529 plan of up to $6,000 per year (individual) and $12,000 per year (married filing jointly) are deductible in computing Idaho taxable income
Illinois Contributions to an Illinois 529 plan of up to $10,000 per year (individual) and $20,000 per year (married filing jointly) are deductible in computing Illinois taxable income
Indiana A 20% tax credit on up to $5,000 per year in contributions to an Indiana 529 plan can be claimed against Indiana income tax (maximum yearly credit is $1,000)
Iowa Contributions to an Iowa 529 plan of up to $3,319 for 2018 per beneficiary (individual) and up to $6,638 per beneficiary (married filing jointly) are deductible in computing Iowa taxable income. The maximum deduction increases each year with inflation. Only contributions made by the account owner are deductible.
Kansas Contributions to Kansas AND non-Kansas 529 plans of up to $3,000 per year (individual) and $6,000 per year (married filing jointly) per beneficiary are deductible in computing Kansas taxable income
Kentucky No state income tax deduction for contributions to 529 plans
Louisiana Contributions to a Louisiana 529 plan of up to $2,400 per year (individual) and $4,800 per year (married filing jointly) are deductible in computing Louisiana taxable income.
Maine Beginning in 2016, no state income tax deduction for contributions to 529 plans
Maryland Contributions to a Maryland 529 plan of up to $2,500 per year (individual) and $5,000 per year (married filing jointly) are deductible in computing Maryland taxable income, with a ten-year carryforward of excess contributions.
Massachusetts From 2017 through 2021, contributions to Massachusetts 529 plans of up to $1,000 per year (individual) and up to $2,000 per year (married filing jointly), are deductible in computing Massachusetts taxable income.
Michigan Contributions to a Michigan 529 plan of up to $5,000 per year (individual) and $10,000 per year (married filing jointly) are deductible in computing Michigan taxable income.
Minnesota Contributions to Minnesota AND non-Minnesota 529 plans of up to $1,500 per year (individual), and up to $3,000 (married filing jointly), are deductible in computing Minnesota taxable income.
Mississippi Contributions to a Mississippi 529 plan of up to $10,000 per year (individual) and $20,000 per year (married filing jointly) are deductible in computing Mississippi taxable income.
Missouri Contributions to Missouri AND non-Missouri 529 plans of up to $8,000 per year (individual) and $16,000 per year (married) are deductible in computing Missouri taxable income. Only contributions made by the account owner are deductible, except for spouses filing a joint return
Montana Contributions to Montana AND non-Montana 529 plans of up to $3,000 per year (individual) and $6,000 per year (married filing jointly) are deductible in computing Montana taxable income. Only contributions made by the account owner or the account owner's spouse are deductible.
Nebraska Contributions to a Nebraska 529 plan of up to $10,000 per year (single and married filing jointly) and up to $5,000 per year (married filing separately) are deductible in computing Nebraska taxable income. Contributions made by the account owner or parents of the beneficiary are deductible.
Nevada Nevada does not have a personal income tax
New Hampshire New Hampshire does not have a personal income tax
New Jersey No state income tax deduction for contributions to 529 plans
New Mexico Contributions to a New Mexico 529 plan are fully deductible in computing New Mexico taxable income
New York Contributions to a New York 529 plan of up to $5,000 per year (individual) and up to $10,000 per year (married filing jointly) are deductible in computing New York taxable income. Only contributions made by the account owner or the account owner's spouse are deductible.
North Carolina No state income tax deduction for contributions to 529 plans
North Dakota Contributions to the North Dakota 529 plan of up to $5,000 per year (individual) and up to $10,000 per year (married filing jointly) are deductible in computing North Dakota taxable income.
Ohio Contributions, including rollover contributions, to a Ohio 529 plan of up to $4,000 per beneficiary per year (any filing status) are deductible in computing Ohio taxable income, with an unlimited carryforward of excess contributions.
Oklahoma Contributions to an Oklahoma 529 plan, including rollover contributions, of up to $10,000 per year (individual) and up to $20,000 per year (married filing jointly) are deductible in computing Oklahoma taxable income, with a five-year carryforward of excess contributions.
Oregon Contributions to an Oregon 529 plan of up to $2,375 for 2018 (individual) and up to $4,750 (married filing jointly) are deductible in computing Oregon taxable income, with a four-year carryforward of excess contributions. The limits are to be adjusted each year for inflation
Pennsylvania Contributions to Pennsylvania AND non-Pennsylvania 529 plans of up to the gift-tax annual exclusion amount ($15,000 in 2018) per beneficiary are deductible in computing Pennsylvania taxable income. Spouses filing jointly must each have at least $15,000 in income to claim the maximum $28,000 per-beneficiary deduction.
Rhode Island Contributions to the Rhode Island 529 plan of up to $500 per year (individual) and up to $1,000 per year (married filing jointly) are deductible in computing Rhode Island taxable income, with an unlimited carry forward of excess contributions.
South Carolina Contributions, including rollover contributions, to a South Carolina 529 plan are fully deductible in computing South Carolina taxable income.
South Dakota South Dakota does not have a personal income tax
Tennessee Tennessee does not have a personal income tax
Texas Texas does not have a personal income tax
Utah Contributions to the Utah 529 plan of up to $1,960 in 2018 per beneficiary (individual) and up to $3,920 in 2018 per beneficiary (married filing jointly) are eligible for a 5% credit against Utah income tax. The maximum credit in 2018 is $98 per beneficiary (single) and $196 per beneficiary (married filing jointly). The credit limits are increased each year for inflation.
Vermont Contributions to the Vermont 529 plan of up to $2,500 per beneficiary per year (individual) and up to $5,000 per beneficiary per year (married) are eligible for a 10% tax credit against Vermont income tax.
Virginia Contributions to a Virginia 529 plan of up to $4,000 per account per year are deductible in computing Virginia taxable income, with an unlimited carryforward of excess contributions. Contributions are fully deductible in the year of contribution for taxpayers at least 70 years of age. Contributions from a non-owner are deductible by the account owner and not by the non-owner/contributor.
Washington Washington does not have a personal income tax
West Virginia Contributions to West Virginia's 529 plans are fully deductible in computing West Virginia taxable income.
Wisconsin Contributions to a Wisconsin 529 plan of up to $3,200 in 2018 per beneficiary per year (any filing status) are deductible in computing Wisconsin taxable income. The maximum annual deductible will be increased annually to reflect inflation. Contributions in excess of the maximum annual limit may be carried forward to one or more future years and deducted
up to the then annual maximum deductible amount each year until all amounts invested have been deducted from Wisconsin taxable income.
Wyoming Wyoming does not have a personal income tax. Wyoming currently does not sponsor a 529 plan.

Source: Savingforcollege.com, 2017

Client Conversations gives financial advisors an easy way to communicate with clients on topics influencing financial markets; it highlights common investor behaviors and offers ways to address the challenges investors face. Share this article with your clients, and remember to follow your firm's policies that govern sharing content with clients and prospects.


1 CNBC, “How these states are rebelling against the GOP tax code,” January 23, 2018.

2 Sallie Mae, 2016. Most recent data available.

3 Non-qualified withdrawals are taxable as ordinary income to the extent of earnings and may also be subject to a 10% federal income tax penalty. Such withdrawals may have state income tax implications.

4 Deductions may be subject to recapture if nonqualified withdrawals are made

5 The Wall Street Journal, “529 College-Savings Plans Are Even Hotter After Tax Overhaul,” 1/5/18

6 IRS, “What’s New – Estate and Gift Tax,” 1/12/18.

Before investing, an investor should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s 529 plan. 

For more information about any 529 college savings plan, contact the plan provider to obtain a Program Description, which includes investment objectives, risks, charges, expenses, and other information; read and consider it carefully before investing. Hartford Funds Distributors, LLC serves as distributor and underwriter for some 529 plans.

This information should not be considered investment advice or a recommendation to buy/sell any security. In addition, it does not take into account the specific investment objectives, tax and financial condition of any specific person. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. This material and/or its contents are current at the time of writing and are subject to change without notice. This material may not be copied, photocopied or duplicated in any form or distributed in whole or in part, for any purpose, without the express written consent of Hartford Funds.

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