Seek 529 Tax Benefits Outside Your State
Some states, including California and North Carolina, dont offer a 529 state tax deduction at all. Then there are states, such as Texas and Florida, which dont levy a state income tax, which means you cant lower a tax burden you dont have.
If youre unlikely to generate much savings by claiming a state 529 tax deduction, it could be a smart move to shop for savings plans outside your state. Here are a few tips to follow when you compare 529 savings plans:
How Much Is The 529 Tax Deduction Worth
The 529 Plan comes with an array of tax deductions which can yield huge savings when you pay for college. But how much are these deductions really worth? The answer can change based on many factors. How much you contribute, the number of years in which you contribute, and the state youre in can all determine how much your deduction is worth. Lets break down all of the relevant factors.
What Is A 529 Savings Plan
A 529 savings plan works in some respects like a Roth retirement savings plan. This kind of 529 allows account holders to open an account and invest after-tax savings in different mutual funds, bond funds and exchange-traded funds for the benefit of a designated childs future qualified education expenses.
This will require making investing decisions: What is your risk tolerance? When will you need the money? Most 529 savings plans will offer an age-based solution in which you can just pick a year, or date range, when you expect your child to go to college, and the portfolio will be rebalanced from stocks to bonds during that time. While this “set and forget” option is popular, it is not without its detractors, some of whom argue that it is too conservative, given the rising cost of higher education.
Only a few state-operated 529 savings plans have residency requirements for savers or beneficiaries. You can invest in any states plan, but most state plans convey state tax benefits and other incentives only to residents of that state.
You can move money between plans as often as once a year for any reason. Contact the plan youd like to switch into to get the forms youll need to make the transfer. Because many states continue to improve their plans, its smart to check out the options every year or so.
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The above article is intended to provide generalized financial information designed to educate a broad segment of the public it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.
Who Can Open An Account
Any U.S. resident can open a New Yorks 529 College Savings Account. You do not have to be a New York state tax payer or resident.
Moreover, you do not need any knowledge of mutual funds. Vanguard Inc. and Ascensus Broker Dealer offer several easy-to-digest investment options for you to choose from. The age-based investment path is one that stands out, but you do not have to choose it if you dont want to.
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What If Your Kids Are Too Young To Work
In this case, you might have to fund the 529 with taxable dollars at first. But use this time while they are growing up to grow that side business so when they hit the proper age, you can indeed hire them.
If you want to get aggressive, there is yet another idea. Hire an older family member and have them fund your childs 529. This is also perfectly legal and works just great.
Can you implement any of these ideas? Why or why not? Do you have any better ideas for funding a degree?
How Total Contribution Affects Your 529 Plan Deduction
Tax deductions lower your taxable income by excluding specific income or expenses from taxation. So, at a tax rate of 20%, a $1,000 deduction would save you $200. The 529 Plan is an opportunity to deduct educational expenses, which can make saving for college much easier.
529 Plan contributions are made from after-tax income. But depending on your state, you may be able to deduct these contributions from your state taxes. So, the more you contribute, the higher your deduction will be. 529 Plan earnings are also exempt from federal taxes. So even if your income is taxed, the earnings in the account will not be.
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Plan State Income Tax Benefits
Many states offer incentives to encourage residents to save for college. Studies show that children who have even a small amount saved for college are more likely to attend and graduate. Having a highly educated workforce can help drive economic growth and development in the state.
More than two-thirds of the states offer an income tax benefit for college savings. The majority of states require taxpayers to contribute to their home states 529 plan to qualify for an income tax benefit, but seven states offer a tax incentive for contributions to any 529 plan:
- Arizona
- Montana
- Pennsylvania
The most common benefit offered is a state income tax deduction for 529 plan contributions. However, Indiana, Utah and Vermont offer a state income tax credit for 529 plan contributions and Minnesota offers a state income tax deduction or tax credit, depending on the taxpayers adjusted gross income.
Plans Are Low Maintenance Investment Accounts
A 529 plan account can be opened online or through a licensed financial advisor. Families who prefer to set it and forget it can select an automatic investment plan linked to a bank account or payroll deduction plan. The ongoing investment management within a 529 plan is handled by the program manager.
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Enjoy A Federal Gift Tax Incentive
You can contribute up to $15,000 per year without triggering federal gift taxes. Or you can choose a special election that allows you to treat a single $75,000 contribution as if it were made over a five-year period.***
Gifts in excess of these amounts may be subject to federal gift taxes. For more information, consult a qualified tax advisor.
How To Choose A 529 Plan
Research the underlying expenses of the mutual funds and review the investment options available compared to other plans. The age-based models may be the easiest to manage, as the plan shifts to more conservative investments as the student gets closer to college age. You can choose any state plan no matter where you live, but if you reside in a state that provides tax breaks for using your state plan, you would likely want to start there. For example, New York residents get tax benefits for using their state plan. Keep in mind that you have the ability to move your 529 to another provider, but only one rollover is permitted per 12-month period.
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The Cost Of 529 Plans Is Set To Rise
As 529 plans mature and more families use them to fund college costs, the price tag to the U.S. Treasury will also rise, unless some reforms are undertaken. Over the next decade, the federal government is set to spend almost $30 billion on 529 tax expenditures, according to Treasurys Office of Tax Analysis. Annual costs are projects to be just under $4 billion by 2026.
Can I Use 529 Plan Money For Any School
Money from a 529 savings plan can be used at any school approved by the U.S. Department of Education to accept Title IV student aid. Approximately 6,000 schools participate in this program. This includes hundreds of foreign colleges and most colleges and universities in the United States.
Excel spreadsheets with information about those colleges can be found on this Department of Education website. You can also look up eligible schools on savingforcollege.com.
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Compound Interest Is A Superpower For Growth
There are other factors to help build up your 529 plan as well as the tax benefits. Compound interest is a major source of growth for any savings program. For a 529 college savings plan, the compound interest is accrued not just on the original contribution but on every contribution. Compound interest is also added to the 529 investment options earnings and the already accumulated interest.
If you would like to see the power of compound interest, use this calculator from U.S. Securities and Exchange Commission to input your information to see how compound interest can build up your college savings account.
The effect of compounding is especially powerful over a long time period as the amount of earned interest can grow larger and larger. This is an excellent reason to start as 529 fund as early as possible for your child.
Is A State 529 Plan The Way To Go
There are advantages and disadvantages to using 529 plans to save for your childs education. For many people, the advantages, including favorable tax treatment, will outweigh any downside, including potential penalties for early withdrawals or for using the money in a way that is not approved.
Its worth paying attention to future changes, including possible federal government forgiveness of student loans and potential availability of free college education. This may affect details relating to 529 accounts and their usefulness.
Also, in selecting a plan, you should make sure you understand the fees and expenses associated with the particular plan. This information will be contained in the plans disclosure statement.
For now, though, on balance, the accounts can benefit families and students by providing tax and other financial advantages that allow money to grow more quickly while creating an incentive to save for educational expenses.
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Overview Of 529 Plans
A 529 college savings account is a tax-advantaged way to set aside money for education expenses. All 50 states offer at least one 529 savings plan, though some may offer multiple options. You dont have to be a resident of a particular state to contribute to that states plan.
The money you save in a 529 account is allowed to grow on a tax-deferred basis. That means you wont pay taxes on earnings until you withdraw your college savings. But as long as those withdrawals are used to pay qualified education expenses, theyre tax-free. Qualified withdrawals include things like tuition, fees and room and board paid to a school thats eligible to participate in federal student aid programs.
In terms of how much you can contribute to a 529 plan, there are two thresholds to keep in mind. The first is the annual gift tax exclusion limit. This limit says that you can gift someone up to a certain amount of money without triggering the gift tax. For 2021, that limit is $15,000 but if youre married and file a joint return, you and your spouse can split your gift and contribute up to $30,000 to a 529 savings plan per child.
The other threshold is the lifetime contribution limit set by the plan itself. This is the amount you can contribute to any single 529 plan on behalf of a named beneficiary over the course of your lifetime. Every plan is different in this regard, though some allow upper lifetime contribution limits in the $300,000+ range.
Qualified Elementary And Secondary Education Expenses
These are expenses for no more than $10,000 of tuition, incurred by a designated beneficiary, in connection with enrollment or attendance at an eligible elementary or secondary school.
*CAUTION Illinois Qualified Expenses do not include expenses for:
- tuition in connection with the Beneficiarys enrollment or attendance at an elementary or secondary public, private, or religious school. The amount of cash distributions for such expenses from all 529 qualified tuition programs with respect to a Beneficiary shall, in the aggregate, not exceed $10,000 during the taxable year.
- If a withdrawal is made for such purposes it may be a Federal Qualified Withdrawal and not be included in income for federal and Illinois purposes, but if an Illinois income tax deduction was previously claimed for Contributions to the Account all or part of that deduction may be added back to income for Illinois income tax purposes.
Please consult with your tax advisor.
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Who Can Get A Tax Deduction For 529 Plan Contributions
Although some facets of 529 plans are set by the federal government through Section 529 of the Internal Revenue Code, many of the specifics are left up to the states to decide. Each state offers at least one 529 plan, some of which carry benefits that others lack â perhaps the best example of which is a state income tax deduction or credit. Whether or not you can get a tax deduction for contributing to a 529 plan will depend on two main points: where you live and whether you own the account.
Different states have different policies in this regard â in some, you can enjoy a state income tax break for contributing to any account, whereas others only grant this benefit to those making donations to an in-state plan in a few states, only the account owner can use the deduction. In seven states â California, Kentucky, Delaware, New Jersey, North Carolina, Maine, and Hawaii â no deductions are available, while another nine have no state income tax from which to deduct contributions. Below, weâve sorted the states that do offer some kind of tax break to clarify whether you might be eligible for a tax deduction for your contributions to a 529 plan:
Coordination With American Opportunity And Lifetime Learning Credits
An American opportunity or lifetime learning credit can be claimed in the same year the Beneficiary takes a tax-free distribution from a qualified tuition program as long as the same expenses arent used for both benefits. This means that after the beneficiary reduces qualified education expenses by tax-free educational assistance, he or she must further reduce them by the expenses taken into account in determining the credit.
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What Are 529s And How Do They Work
529 plans are state-operated savings accounts, named after Section 529 of the IRS Code that codified them in 1996. The original 1996 legislation deferred tax on undistributed earnings. The Economic Growth and Tax Relief Reconciliation Act of 2001, signed by George W. Bush, then made earnings growth completely tax-free . The provision became permanent in 2006.
Since the mid-2000s, the growth in 529 plans has been considerable. By the end of 2016, total asset values in 529 plans reached $275 billion. But in the general population, 529 plans are little understood and little used in one survey, 72 percent of respondents did not know what they were.
529 plans have several defining features:
- Funds must be used for qualified educational expenditures
- No income-eligibility threshold
- Waiver from the standard gift expensing rule allows families to superfund accounts
- Grandparents are allowed to contribute
- Only a small fraction of 529 assets count in making financial aid calculations2
- Many states offer income tax deductions for contributions
- No residency requirement
A few of these provisions are relatively unusual, so we provide a few more details here.
Qualified educational expenses
Waiver on tax rules for gifts
State-level benefits
Plans Offer Considerable Convenience And Potential Tax Savings When Putting Money Aside For Education That Said There Are Still A Range Of Rules Youll Need To Know
The U.S. government has given favorable tax treatment to so-called 529 plans for 25 years. Still, just a little more than a third of Americans know 529s are a potentially powerful educational savings tool, according to a 2021 study by Morning Consult with financial services firm Edward Jones. Just 20% of parents reported using or planning to use 529 plans to save for their childrens education.
As of June 2021, there were more than 15 million 529 accounts owned around the country and more than $464 billion has been saved through the plans, according to the College Savings Plans Network.
Could your family take advantage of the tax savings of a 529? This quick guide should help you understand the basics of 529 plans and answer your questions:
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Rules For Claiming The Section 529 Deduction
The state of Connecticut offers one of the higher tax deduction limits for residents who contribute to a Section 529 college savings plan. Single taxpayers can deduct up to $5,000 in Connecticut Higher Education Trust contributions or $10,000 for couples filing jointly.
Connecticut residents who contribute more than the maximum deduction for any year to a CHET plan are permitted to carry it forward for up to five years. In other words, a single parent who makes a $6,000 contribution to the CHET plan could deduct $5,000 this year and the remainder the following year.
And as with most states, distributions from the Connecticut Section 529 plan that are used for qualified education expenses are not subject to taxation.