What Tax Reform Did for 529 Plans

Find out why parents can do more with these tax-favored plans now.

Last year's tax overhaul made huge changes to key provisions of the tax code. Substantial rate reductions were included in the final version of the bill, and its provisions expanded certain tax breaks while eliminating or restricting others.

Named after the section of the tax code enacted two decades ago, 529 accounts allow savers to contribute dollars after federal taxes have been paid on them. The assets are invested and can grow free of federal and state taxes.

Withdrawals are tax-free if they are used to pay eligible education expenses such as college tuition, books, and often room and board.

What the new rule does

Section 11032 of the Tax Cuts and Jobs Act made an amendment to the existing Section 529 of the Internal Revenue Code, which is the provision that created college savings plans and is where the popular 529 plan name came from. The new law now includes Section 529(c)(7), which adds to the definition of "qualified higher education expense" any expenses paid for tuition "in connection with enrollment or attendance at an elementary or secondary public, private, or religious school."

In practical terms, what that means is that funds in 529 plans are now available for tuition for those in kindergarten through 12th grade. If a child goes to school at an institution that charges tuition, you can take distributions from a 529 plan to pay it, and any earnings from those distributions will be fully tax-free -- just as they would be if you'd used the money for permitted college expenses.

Some limits and challenges with the new rule

The last-minute addition raised some controversy, much of which centered on disparate views regarding tax breaks for religious school education. There are also some things that parents need to keep in mind with the new provisions.

First, there's a limit on parents' ability to take 529 plan distributions for elementary, middle, or high school expenses. A maximum of $10,000 is allowed each year for those purposes. No such annual limit exists for college expense withdrawals.

Also, not all states will necessarily follow the same tax rules regarding K-12 withdrawals as the new federal rules. What that means is that if you take a withdrawal to cover pre-college educational expenses, you might have to pay state income tax and penalties on the money with