Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Some of the less-discussed aspects of the recently enacted tax package affect people saving for college and pre-college expenses. Joining me to discuss some of them is Tim Steffen, he's director of Advanced Planning for Baird.
Tim, thank you so much for being here.
Tim Steffen: Thanks.
Benz: I'd like to discuss one aspect of the tax package that maybe has gotten little less attention, and that's the implications for people who are paying for college. Let's start with the headline really, which is what's going on with 529 assets; they now may be used to pay for K-12 expenses?
Steffen: They've expanded the definition of qualified expenses for 529. Now you can use 529 accounts, it used to be just for college expenses, for secondary, is what they call it. Now you can use those for K-12 expenses as well. If you are sending your child to a private school, religious or nonreligious, it doesn't matter, any kind of private school, you can use 529 money to pay for that expense. It is capped, it's $10,000 annual limit per beneficiary. Each child can pull $10,000 out of 529 to pay for K-12. But considering it was zero before that’s a big change.
Benz: Right. You mentioned though before we got started here that this is the federal rules; what the states are doing is an open question at this point. Let's talk about that.
Steffen: The federal rules allow you to take money out, penalty-free and tax-free from a 529 for K-12. But the states aren't necessarily all in line with that. Some states, their tax code is set to automatically change to match whatever the federal rules are, in terms of deductibility and taxability and that kind of thing. That's about 20 or so states. The others though require legislation within the state to say, we're going to adapt these federal provisions. For those states right now, if you took money out of a 529 and used for K-12 they might actually penalize you or tax you on the income that you take out. You've got to be a little bit more careful if you live in one of those states, and it's roughly 30 states or so, it’s a pretty lengthy list. You are going to want to check with your state first to verify that they are conforming or nonconforming, and if they are nonconforming, what is their plan to become conforming.
Benz: I wanted to discuss the investment implications, if someone is saving for K-12 expenses in a 529 plan, doesn't sound like they'd want to opt for one of those age-based programs that is geared towards someone in college. How should they approach this decision?
Steffen: Yes, you are saving for particular goal, and your timeline for that goal, if you've been putting money into a 529 for college and now all of a sudden you want to use it for K-12, your goal just accelerated quite a bit. Now your investments need to be in-tune with that. You are generally going to to get a little more conservative, maybe a lot more conservative with your investments, because you've got less time to recover if the market goes downward on you. If you lose some money you want to be more conservative with those investments.
Some of the age-based accounts, correct--are designed for people who are going to college. They are saying as the beneficiary hits 18, they start changing the portfolio. What you may see now is some more flexibility set up with those. Funds might offer an age 10 model or an age 15 model or something like that, or they'll say rather than tying it to a particular age do you want a three-year model or five-year model or a 15-year model. That way you are not tied to an age but tied to a time period in which you are going to use the money. If you've got a kindergartener who you will putting money in there now, but pulling out in a few years, you want a shorter-term portfolio. You'll either have to stay away from the age-based funds or find some that are more geared toward your shorter time period.
Benz: Someone might hear this and think well why do I even want to monkey with getting this money invested, if I plan to use it in such a short term. But there are state tax deductions to be had by running the money through a 529 plan.
Steffen: Many states offer it. There is no federal deduction for putting money into a 529 but many states do offer some tax incentives for contributing to a 529. They are very limited in some cases, some say you can only do it if you contribute to our state's plan; others are more flexible on that. The benefit is when you really run the numbers not maybe as great as you might think, but it's something to consider. Even if you plan to use it for K-12, you might get a tax benefit today for funding it.
Benz: There were lot of things on the education funding front that did not change, that had been rumored to change as part of this tax package. I just want to address them. Coverdell accounts, these are also accounts that people could use for K-12 expenses as well as college expenses. Let's talk about what's going on there.
Steffen: What's going on with Coverdells is really nothing new. It didn't change. The original proposal had suspended contributions on Coverdells; that did not happen. If you are contributing to a Coverdell you can continue to do so, but with the change to the 529s, Coverdells, while they aren't going away technically, they for all practical purposes …
Benz: Kind of getting marginalized it seems like.
Steffen: Really. They were never a great account to begin with, small dollar contributions, AGI limits, and who could contribute, the need to liquidate it by a certain age. They were never great accounts, but they were all we really had. Now that you've got the 529, you may find that Coverdells just on their own tend to go away.
Benz: I want to discuss ABLE Act accounts, what's going on there. They did in fact see some expansion.
Steffen: Little bit. ABLE accounts are often lumped in with the education accounts. Even the code section is 529A so they are often lumped in with education, but it's really a separate thing.
Benz: Let's talk about what they are, who they are geared toward.
Steffen: ABLE accounts are really meant to be a tax-preferred way for disabled individuals to save money, while still qualifying for federal benefits.
Benz: Without having to set up a special needs trust and so forth.
Steffen: Exactly, exactly. You can put money into the account, it's not deductible, there is no deduction for contributing to it. But the earnings will go in a tax-deferred and then, when they are pulled out they can be tax-free if the beneficiary is disabled. There are limitations on that: You are limited to the annual gift contribution, which for 2017 was $14,000, for 2018 is now up to $15,000. That's the limitation on contributions. What they did under this tax law is they said once you hit that $15,000, the beneficiary can actually put some of their money in based on how much they are earning during the year.
Benz: Based on the beneficiary's own earnings.
Steffen: Correct. If the disabled individual is working somewhere, has a job, they can use their earnings to make additional contributions to the ABLE account. That's a fairly big expansion, to those accounts.
Benz: Let's talk about what's going on with student loan interest. This is another line item that people had thought maybe would no longer be deductible. Let's talk about that.
Steffen: The student loan interest deduction was one that was going to go away under some of the earlier proposals. It ended up not happening as part of the final one. There is still a deduction for student loan interest. It's fairly limited, it's only a couple of thousand dollars or so and there is AGI limitations. Higher-income earners are not going to be able to claim the deduction anyway. But it was something that helped reduce the cost of some of those student loans. That did stay intact so those are still out there.
Benz: From a practical standpoint, though, with these new higher standard deduction amounts, how likely is it that someone would have student loan interest that would swamp the standard deduction?
Steffen: Actually the student loan interest deduction was considered an above the line deduction. It's not an itemized deduction, so really anybody could take that deduction if you met the other requirements. You don't have to be an itemizer. The new standard deduction won't impact the student loan interest.
Benz: Good to know. Finally let's talk about tax credits, what's going on there with the education related tax credits.
Steffen: Again, a whole lot of nothing, as it turned out to be. The thought was to consolidate some of the existing tax credits into an expanded American Opportunity Credit; that didn’t happen. The American Opportunity Credit is still there, that’s roughly $2,500 you can claim a credit for based on how much you are paying in tuition bills. There is also the lifetime learning credit, which is out there as well and that still exists. Now you can only claim one or other; it would have been nice if they could have consolidated, made things a little simpler. They didn't, that's OK, so it's kind of status quo on those two.
Benz: Tim, great recap. Thank you so much for being here.
Steffen: Thanks, Christine.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.