On the New 529 Rules

The folks at the Carney Sandoe blog published a post today summarizing what we know about the changes in the tax code that will permit families to pay K-12 independent school tuition using funds drawn from 529 plans. Funds from 529s were heretofore restricted to higher ed expenditures, so this is a significant change. I learned something new from the CSA post, namely that certain individual states have write their own regulations that forbid this expansion of 529 expenditures; New York and Illinois for example. (Yes, this is a politicized red state/blue state matter, but the CSA blog post eschews that angle.)

A lot has been written about all of the problems with this change to 529s, and I won’t repeat it all here. (See Ron Lieber in the NYTimes, here.) While the pundits and analysts agree that this change is mostly a windfall for the wealthy, I haven’t seen enough written about the damage it may do to middle class families trying to save for college.

When I opened a 529 two years ago after the birth of my son, the rules of the game were clear: the money I accrued in the account wouldn’t be touched until he began college. I made calculations regarding how much I would need to save per year based on assumed rates of return on investment and inflation in college tuition. Now that math is under assault.

If my wife and I choose to send our son to independent school at any point in his K-12 years, that school may make financial aid calculations based on an expectation that we will draw upon the funds in our 529 to pay their tuition bill. The more successfully we save for our son’s college education, the more bloated and enticing a pinata our 529 will become for that independent school! Will this force middle class families to abandon the idea of sending their kids to independent schools? The change in the tax code appears on the surface to be a life raft for independent schools that are currently struggling to meet their revenue targets, but what if it has the opposite effect and reduces their admissions funnels?

There simply isn’t enough money to go around in middle class families’ budgets to fund a 529 that will be drawn upon for K-12 and higher ed expenses. College is mostly unaffordable for middle class families now, but the one thing that disciplined savers have going for them is the power of the tax-sheltered compounding inside the 529 that can, if they are lucky, exceed the growth rate of college tuition by a few percentage points over the course of two decades of saving. That will, if one doesn’t bungle one’s asset allocation and get stung by bad timing in the economic cycle, close some of the gap and help one pay for college. If money is being leeched out by K-12 tuition along the way, it won’t be invested long enough to allow the market to do its thing. Yes, it makes sense for anyone making K-12 tuition payments to cycle that cash through the 529, even if just for the minimum amount of time required to get the tax benefit. I worry that financially unsophisticated families without tax advisers won’t be able to handle the extra complexity this brings to their lives, which returns us to the conclusion that this change in the tax code is really just going to benefit the wealthy.



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