Micro-Geographic Arbitrage with 529 Plans

The recent tax reform bill that made its way through the legislative gauntlet of the US government brings with it a host of new changes, which will affect investors from all walks of life in big and small ways starting in 2018. One of the less covered but equally important changes is the extension of tax benefits for the 529 plan that many families use to save money for their children’s post-secondary education. At first glance, the change may not seem like much, but for those of us optimization minded financiers, it may make a huge difference in savings.

With the new tax bill, the qualifying expenses for the 529 plan have been expanded to include tuition for private schools at the primary and secondary levels, that is, from kindergarten through the 12th grade (K-12). Private school is typically associated with the high-brow, affluent amongst us that decide public education is not good enough for their children. However, with the rising cost of living in many metropolitan, costal areas such as the San Francisco Bay Area, the choice between public and private schools is actually more than simply a educational values judgement.

For a family with a heavy emphasis on education but more modest means, it may not be feasible to live in areas with good public education throughout the K-12 levels. For these families, a micro level of geographic arbitrage may come into play: buy or a rent a house in a lower cost of living area, and use the savings in housing costs to put school age children in better, private schools. With the 529 plan changes to include K-12 private school tuition, this strategy actually becomes even more attractive. These families can use the money they reaped from savings in housing costs, plow those after-tax dollars into 529 plans for their children, and start withdrawing up to $10,000 a year without having to pay taxes on any capital gains.

Ultimately, any money leftover after the primary and secondary school periods can still be used for higher education, so there’s very little downside for a family to start contributing more money even earlier in their children’s life. Add on the deduction that certain states offer from state taxes for 529 contributions, and 529 plan becomes a great tool for opportunistically using micro-geographic arbitrage to optimize a family’s quality of housing and education.