529 Savings Plans: Getting Creative with a Tax-Free Investment Structure

November 4, 2021

Career / Business, Planning & Saving

Can I get a massive tax deduction for my kids’ yeshivah tuition now? wondered Chaim Weinstein. Three of his kids were married, but he still got hefty bills for the other three who were in high school, beis midrash, and seminary, respectively. He’d come across a tidbit mentioning that New Jersey was now offering huge tax deductions for funds placed into 529 college savings plans. The newspaper said that these plans allowed for tuition payments to private school tuition such as yeshivos!

What are 529 plans? Can they be used by frum families to lower taxes and tuition burdens?

Getting to Know 529s

529 college savings plans have been around for about over 20 years. But since attending expensive universities isn’t a priority for most frum families, they didn’t really play a role in frum financial planning. However, under President Donald Trump, these tools were expanded to allow tax-free withdrawals toward K–12 school tuition. This change increased their utility significantly for frum people. And New Jersey since passed new laws offering a new 529 tax break and expanded grants for using its state-run plan. So it’s time to explore these powerful wealth enhancers more carefully. They are a bit tricky, and 529 misconceptions abound, so hang on.

What is a 529 Savings Plan?

As college costs kept rising and the economic value of higher education grew, Congress passed laws (in 1996, 2001, and 2006) offering tax discounts for college savings taking place within special 529 plan accounts. These plans are set up and overseen by states, which delegate the actual day-to-day operations to an investment or trust company such as Fidelity, Vanguard, Ascensus, etc. Most states have two plans, one offered via brokers and another “direct” option, allowing savers commission-free access to a 529 plan. This is why there are so many 529 plans out there—approximately two for each of the 50 states.

529 Basics

All the plans follow the same basic structure. The account owner fills out an application, opening a 529 account to save up money toward someone’s future education. That someone, known as the account’s beneficiary, can be anyone—yourself, a child, a grandchild, a nephew, or even some kid from your shul. The account is then funded with cash to be invested into one or more of a small menu of mutual funds offered by the plan. These investments grow tax-free—as long as they are withdrawn only for “qualified education expenses,” the dividends, interest, and gains are not taxed at all.

Compare to an Unlimited Roth IRA

Most states, including New Jersey and New York, follow federal rules for 529 plans. Considering that combined top tax rates for investment gains can easily reach 25–50%, tax-free investment growth increases net investment wealth massively. The tax structure offered here is similar to a Roth IRA’s. But unlike the Roth, 529 plans can be funded by anyone, regardless of income. And whereas retirement accounts limit annual contributions to as little as $12,000 per couple, 529s can be funded in an almost unlimited capacity. As a long-term investment vehicle, 529 plans offer a lot of scope for creative tax-free investing.

Minimal Short-Term Benefits

Unfortunately, 529 plans do not offer the immediate tuition assistance that Klal Yisrael needs so badly. The federal government offers no tax deductions or credits for money deposited in 529s, and most states offer minimal deductions. New Jersey matched New York’s $10,000 deduction (per couple) for 529 contributions, but this will, at most, lower a tax bill by a few hundred dollars annually. The primary largesse offered toward 529 accounts is not taxing future investment growth produced by these sheltered accounts. This benefit is only truly useful for those who can tie up significant funds for years, not cash-strapped young families who need money for tuition now.

Large Long-Term Benefit

Considering that 529 accounts have certain fees and restrictions, it’s not worth hassling with them for small sums invested for the short term. The $10,000 maximum deduction just for New Jersey taxes is pretty small potatoes. But say a middle-aged couple in their 50s have a solid income which more than covers their current needs, and their retirement accounts are already funded sufficiently to cover future needs too. Where are their additional savings headed for the most part? To help out their kids and grandchildren. And what will be a major part of their children’s financial needs? Tuition.

Tax-Free Education Assistance

For simplicity’s sake, imagine the Weinsteins have $600,000 they’d like to invest toward helping their kids in the future. If they just dump that into a regular portfolio of mutual funds, any withdrawals made would be taxable, significantly diminishing the help they can provide. Instead, they can open 529 accounts, naming their children as beneficiaries. (Down the road they will follow a simple process to open and fund separate accounts for each of their einiklach, using their parents’ 529 accounts). Then, every year, tuition funds can be withdrawn from the 529 accounts tax-free.

Big Bucks Required

It may sound a bit odd to tie up so much money in accounts restricted for education, but let’s think about this. Say six kids will, over the next couple decades, each have an average of six children. The cost of educating those 36 einiklach will easily be at least $2 million (36 kids x 12 years of schooling x $5,000 = $2,160,000). Add in higher projected tuition, inflation, beis midrash, seminary, and even kollel housing—an allowed expense under 529 rules—and the figure is much higher. By using a 529 structure, some or all of this “liability” can be covered with tax-free investment growth.

A New World

529 plans are a whole new world for most, and there are further options, rules, and benefits to explore. One interesting idea is using 529 plans for tax-free simcha savings. Also, New Jersey is now offering two grants for those who use their 529 plans. The first is a $750 match (per account) for those with AGIs (adjusted gross incomes) under $75,000. After three years, those granted funds are totally unrestricted. Another grant, open to all New Jerseyans, offers as much as $3,000 to be used for higher education in New Jersey (including BMG, etc.).