California parents have a new option to save for K-12 private school — but there's a catch

San Francisco Chronicle​

10 hours ago

The GOP tax megabill signed into law in July had a provision tucked into it that could help parents who send their kids to private school.
As students head back to school this month, a disproportionate number in the Bay Area will be at private schools: In several counties, rates of attendance are more than double the 8% statewide average. Nearly one-third of K-12 students in San Francisco attend a private school, according to data website Private School Review.
That attendance comes with a hefty price tag. The average amount a family would spend to send their child to private school in San Francisco from kindergarten through high school graduation is about $520,000, according to a Chronicle data analysis.
To help cover those costs, parents will soon be able to leverage an increased amount from 529 education savings plans.
What are 529 plans and how are they changing?
Created by Congress in 1996 and named for a section of IRS code, 529 plans are tax-advantaged investment accounts operated by states or educational institutions designed to help save for a child's education.
They were originally intended to cover college or trade school costs, but since 2018, the law has allowed families to withdraw up to $10,000 annually from 529 plans for K-12 tuition without paying a penalty or federal taxes on the growth.
Starting next year, under the tax and spending bill signed by President Donald Trump on July 4, the K-12 withdrawal limit increases to $20,000.
The bill also expanded what K-12 expenses could be covered. Under previous law, only tuition for K-12 was eligible for federal penalty-free 529 withdrawals; under the new law, expenses like books, tutoring, standardized and AP test fees, and educational therapies for students with disabilities are all considered qualified expenses.
Some states have changed their laws so parents don't pay a state penalty or tax on those K-12 withdrawals either. But not in California. K-12 expenses are still considered nonqualified expenses, so you'll pay a 2.5% penalty plus state income taxes (as high as 13.3%, depending on your household income) on the taxable growth when you withdraw 529 funds for those purposes.
Given that, does it ever make sense in this state to use your kid's 529 funds to pay for their private school tuition or other pre-college educational costs in California? It could. Here's what experts say.
The case against using a 529 for K-12 expenses
Richard Pon, a certified public accountant and certified financial planner, has a son who's enrolled in private school in San Francisco. He said he doesn't use 529 money to pay for it.
The first reason is the state income taxes and the 2.5% penalty. The other reason is the flexibility of 529 funds: Even if your child gets a free ride to college with room and board paid for, those funds could be used to pay for graduate school, professional certifications like a CPA license or nursing license, or get rolled into an IRA. You could also roll the 529 funds into an account for another child or relative, or a friend.
And if you're using 529 funds to pay for elementary school, that means they don't have time to grow in the market before your child goes to college — though, of course, there's always a chance they could drop between now and then, too.
If you're really in a financial bind and paying for your kid's private school tuition from their 529 means the difference between paying your mortgage or not, then yes, it could make sense to tap those funds — though many 529 accounts are protected by federal law in bankruptcies, so if you're truly at the edge of financial peril, you may want to leave the money in that account alone.
In general, Pon said, 'I would think about holding this (money) as long as possible instead of saying, 'Hey, I'll use it for K-12.''
The case for using a 529 to pay K-12 expenses
For some families in California, it might make sense to pay K-12 educational costs from a 529, said Sean Pyles, a certified financial planner and the host of NerdWallet's 'Smart Money' podcast. He said to think of 529s less as college savings accounts and more like flexible education savings accounts.
When it comes to the tax question, parents can do the math and see if using the funds for K-12 expenses pencils out.
'What it's going to come down to for each person is figuring out whether they are going to be coming out ahead by actually reaping tax benefits from this account, or if, given the amount (of taxes and penalties) that California imposes, it's just not going to be financially beneficial to them at this point,' he said.
For parents making the investment in private schools for their kids, it's probably worth checking with an accountant, financial planner or other tax pro to see if the math makes sense.