If we are to believe the Republican policymakers who control the current attempt to overhaul our tax system, a big point of the exercise is to help the middle class. So how best to explain a possible tax break of more than $30,000 per child for wealthy families who send their kids to private school?
That number is the potential net tax savings, under the House tax plan, for parents who deposit a large amount of money when their kids are born. They would get that benefit by using the money for children starting private school in kindergarten and attending through high school.
Buried in Section 1202 of the tax bill are a number of proposals to consolidate and simplify various tax breaks for education savings. Part of the section in effect would neuter something called a Coverdell account, which families have used for years to save for both private school and college.
But then comes the big change: Elementary and high school expenses of up to $10,000 per year would become “qualified” expenses for 529 plans. Translation? You could pull $10,000 each year out of your 529 account for private school and avoid paying taxes on any previous growth. There are no income limits on who can use 529 plans, and you would be able to keep right on saving for college as well.
The Joint Committee on Taxation estimates that this will reduce federal revenue by $600 million between 2018 and 2027.
So how did this proposal come to pass? Like many things that are important to relatively few people but find their way into large bills nevertheless, it’s kind of a long story.
First, about those Coverdells. They are named for Paul Coverdell, a Republican senator from Georgia in the 1990s who wanted to create tax breaks for parents whose children do not attend public schools. In 2001, President George W. Bush signed a bill allowing holders of the accounts to use any earnings in them for tuition in kindergarten through 12th grade (college, too).
The rules, however, capped annual contributions at $2,000. That limited how much of a benefit you could get over 15 years or so by avoiding capital gains taxes that you would have otherwise paid in a different savings vehicle that offered investments in stocks and bonds.
The provision in the new tax bill, which echoes a legislative attempt in 2012 and an idea that the conservative Heritage Foundation suggested then, proposes to end contributions into Coverdells (except for rollover contributions). Then it adds the $10,000 sweetener: You could pull that much out of 529 plans, which are currently a savings vehicle only for college and graduate school, and use it for K-12 tuition. And 529 plans have few if any contribution restrictions and very high limits on balances.
Now, a quick 529 refresher. You put money in, and in 35 states you get some sort of tax break when you do so, according to Andrea Feirstein, a plan consultant. The money grows tax free, and when you withdraw it to pay for higher-education expenses, you pay no taxes, capital gains or otherwise.
So what would it mean to add private school benefits to 529 plans? Take a wealthy family in the highest tax bracket. It has a newborn baby, and through some combination of gifts and its own savings, it opens a 529 plan with $200,000 and never deposits another dime.
If the money grows at 6 percent annually, that family could take out the $10,000 each year, avoiding $2,380 in taxes annually. If it did that for 13 years (kindergarten through 12th grade), it would save $30,940 in taxes. Plus, according to numbers that Vanguard ran for me, it would still have enough left over after high school ($370,717) to pay for many pricey private colleges in full, as long as tuition inflation there ran no more than 3 percent annually.
And once college began, the family could withdraw as much as the entire annual cost of college and related expenses (not just $10,000), avoiding taxes on any gains all the while.
It sure seemed to me — someone who has used the Coverdells for private school tuition, but who worries about being able to save a decent chunk for college while also using 529s for any future K-12 tuition for two kids — that this was a giant gift to a tiny slice of the wealthiest people in America.
That’s not, however, how some people see it. Robert C. Enlow, president and chief executive of EdChoice, a school-choice advocacy organization, reminded me of the move that many families are able to make when it’s time to pay college tuition each year. Even if they have saved nothing, they’ll drop that term’s tuition money into a 529 account to pick up that year’s state tax deduction. Then they’ll pull the money out right afterward to pay the bill.
That can be worth a couple of hundred dollars right then and there, and if the House bill passes, the same opportunity will exist for families 13 times before college. You may even be able to do this with money you have borrowed.
Not all wealthy families with children in private school would take advantage of a provision like this. Some have financial advisers who steer them away from 529s, because they think that the investments are unsophisticated or that the accounts have too many restrictions. Other individuals don’t want to tie up that much capital in savings that could be used to smooth over rough patches if their income is variable.
Then there are still large numbers of people who find 529s — with their dozens of state-based iterations and differing state tax benefits and menus of investments — confusing to the point of absurdity.
For every other 1 percenter with a family, however, this sure seems like an extraordinary gift. And it will be fascinating — and revealing — to see how long it remains under the big tax Christmas tree.