Income Tax Planning And 529 Plans
The income tax benefits offered by 529 plans make these plans attractive to parents interested in saving for college. Qualified withdrawals from a 529 plan are tax free at the federal level, and some states also offer tax breaks to their residents. It’s important to evaluate the federal and state tax consequences of plan withdrawals and contributions before you invest in a 529 plan.
Coordination With The Coverdell Education Savings Account And Education Tax Credits
You can fund a Coverdell education savings account and a 529 account in the same year for the same beneficiary without triggering a penalty.
You can also claim an education tax credit in the same year you withdraw funds from a 529 plan to pay for qualified education expenses. But your 529 plan withdrawal will not be completely tax free on your federal income tax return if it’s used for the same higher education expenses for which you’re claiming a credit.
Note: Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. More information about specific 529 plans is available in the issuer’s official statement, which should be read carefully before investing. Also, before investing, consider whether your state offers a 529 plan that provides residents with favorable state tax benefits.
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State Income Tax Treatment Of Qualified Withdrawals
States differ in the 529 plan tax benefits they offer to their residents. For example, some states may offer no tax benefits, while others may exempt earnings on qualified withdrawals from state income tax and/or offer a deduction for contributions. However, keep in mind that states may limit their tax benefits to individuals who participate in the in-state 529 plan.
You should look to your own state’s laws to determine the income tax treatment of withdrawals . In general, you won’t be required to pay income taxes to another state simply because you opened a 529 account in that state. But you’ll probably be taxed in your state of residency on the earnings distributed by your 529 plan unless your state grants a specific exemption. Also, make sure you understand your state’s definition of “qualified education expenses,” since it may differ from the federal definition.
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Establish A Coverdell Account
A Coverdell Education Savings Account allows interested parties to save for a designated beneficiary’s college expenses while the beneficiary is under 18 years old. Contributions are not tax-deductible, but distributions are tax-free as long as they are used on qualified educational expenses. The beneficiary can receive a contribution of up to $2,000 each year. The account is part of the student’s assets, so funds in it may influence the type and amount of financial aid available for the student.
Quantifying The 529 Tax Break
529 plans are relatively young, however, and both the costs to the federal government and the benefits to affluent families are likely to rise, assuming no change in policy. To estimate distributional impacts, we estimate the value of the federal subsidy for married parents with two children on different rungs of the income ladders. Specifically, we look at families living at the:
Family at 100 percent of federal poverty line
In 2016, the federal poverty line for a family of four was $24,300 a year.6 Among the very small proportion of such families saving into 529 plans, the typical amount is just $495 a year, according to a survey conducted by Sallie Mae.7 Although in practice savings tend to increase with the childs age, we assume a consistent annual contribution throughout the childhood of the beneficiaries. We also assume the investments are in a stock portfolio, with an annual return of 6 percent, a reasonable rate according to Vanguard data.8
Family making national median income
The just upper-middle class family
The rich super-saver family
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Iowa Taxpayers Can Use College Savings Iowa 529 Assets To Pay K
Qualified withdrawals from your account can be used to pay for tuition, room and board , books, supplies, fees and equipment required for enrollment or attendance at any eligible educational institution in the United States or abroad, as well as computers or certain peripheral equipment, certain computer software or internet access and related services that are to be used primarily by the Beneficiary during any of the years the Beneficiary is enrolled at an eligible educational institution.
Additionally, qualified withdrawals include fees, books, supplies and equipment required for participation in an apprenticeship program registered and certified with the Secretary of Labor under the National Apprenticeship Act, and amounts paid as principal or interest on any qualified education loan of the beneficiary or a sibling of the beneficiary provided that the total amount that may be used from all accounts for repayment of loans of a beneficiary may not exceed $10,000. You should consult your tax advisor for more information.
Favorable Gift Tax Treatment
Contributions to Virginia529 accounts are treated as a completed gift by the account owner to the beneficiary. This means contributions up to $15,000 a year, or up to $30,000 if married, are gift tax free. Additional gifts made to the beneficiary in the same tax year must be taken into account for purposes of determining the $15,000 limit has been met. You may also elect to take advantage of a special five-year averaging provision which exists for Virginia529 accounts. This means a single $75,000 contribution or $150,000 if married and filing jointly may be treated as if it were made over a five-year period. Additional contributions are permitted beyond these limits however, such contributions may be subject to gift tax. You should consult your tax advisor regarding the specific tax consequences of additional contributions.
1. The examples are provided for illustrative purposes only and are not meant to provide you with tax advice. Your tax consequences depend on your individual circumstances. You should consult your own tax advisor regarding specific tax consequences of using the deductions in the manner described above.
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Annual Gift Tax Exclusion
One of the many benefits of saving for a childs future college education with a 529 plan is that contributions are considered gifts for tax purposes. In 2021, gifts totaling up to $15,000 per individual will qualify for the annual gift tax exclusion, the same as in 2020, in 2019 and in 2018. This means if you and your spouse have three grandchildren you can jointly give $90,000 without gift-tax consequences, since each child can receive $15,000 in gifts from you and $15,000 in gifts from your spouse. Remember, the annual gift tax exclusion amount also includes non-529 gifts so be sure to include any cash or property gifts in your total.
If your total gifts to an individual will be more than $15,000 this year, the excess amount will count against your lifetime estate and gift tax exemption and will have to be reported on Form 709 when you file your taxes. In 2021 individuals can gift up to $11.58 million without having to pay federal estate or gift tax. There is no joint gift-tax return, so you and your spouse will each have to file separately.
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.
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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.
What Is The Right Solution For You
Another approach for parents and grandparents may be to combine the features of custodial accounts and 529 college savings plans with a custodial 529 plan account. When the student takes ownership of the account, they must use the money for college expenses or pay a penalty. A custodial 529 account still counts as a parental asset even when the student takes ownershipin contrast to the UGMA/UTMA account which is always considered an asset owned by the child.
The contribution limits for a custodial 529 account align with the limits for a UGMA/UTMA account. For federal tax purposes, the annual contribution limit is the federal annual gifting limit currently in effect for the year in which a contribution is made to an account$15,000 in 2020.
Also, you cannot make an accelerated gift to a custodial 529 account.
Alternatively, grandparents can pay for college directly. For estate planning purposes, the advantage of paying directly is that the payment is not considered a gift. So, a grandparent could still use their annual gift exclusion to give up to $15,000 to the same grandchild. The downside is that a direct tuition payment could potentially reduce subsequent financial aid. Another potential downside is losing years of tax-advantaged savings offered with a 529 plan or a Coverdell ESAbut every situation is different.
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Federal And State Tax Deduction Rules For 529 Plans
The federal tax deduction rules for 529 plans are straightforward. Unfortunately, the federal government does not allow families to deduct contributions to a 529 plan. There is no indication that this rule will change anytime soon.
Families should note that while the federal government does not reward 529 contributions, it does penalize early withdrawals. Families can make 529 withdrawals in any amount without penalty as long as the withdrawal is used for qualified educational expenses. However, families will pay a 10% penalty for any withdrawals made for noneducational purposes.
While federal tax rules do not allow families to deduct 529 contributions, states have their own policies. Remember that each 529 plan is owned and operated by a state government. Therefore, many states allow families to deduct 529 contributions on their state taxes.
Tax Benefits For Each State
In some states, contributions to any states 529 plan are eligible for a state income tax advantage. Out-of-state investors are not required to choose their home state plan to get the benefit but can select any states 529 plan, including the low-cost NEST 529.
NEBRASKA with the NEST Direct College Savings Plan taxpayers can deduct up to $10,000 in contributions from their Nebraska taxable income each year .2
Before investing, investors should consider whether their or their beneficiarys home state offers any state tax or other state benefits such as scholarship funds, financial aid, and protection from creditors that are only available for investments in such states qualified tuition program. Investors should also consult their tax advisor, attorney, or other advisor regarding their specific legal, investment, or tax situation.
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There Are No Federal 529 Plan Tax Deductions
While 529s are similar to 401s, the tax advantages and rules are not identical.
One major difference is that, unlike a 401, you cannot get federal 529 tax deductions for your contributions to this account. While certain 401 and individual retirement accounts offer the chance to save for retirement in pretax dollars, theres no correlating federal tax benefit for 529 accounts.
State Income Tax Benefits
Withdrawals are exempt from New York State income tax when used for qualified higher education expenses. New York taxpayers can also deduct up to $5,000 of contributions on their state income tax return each year. If you are a resident or taxpayer of the another state, you should consider whether that state offers a 529 plan with tax advantages or other benefits that are not available through this Program.
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Who Really Benefits From 529s: Parents Or Colleges
A common defense of 529 tax advantages is that college is becoming an expensive proposition, even for relatively affluent families. As the liberal economist Jared Bernstein reflected on the 2015 reversal of the 529 reforms: following that experience, and from the debate over free, or debt-free, college in the presidential campaigns, Ive come to see the problem of college affordability as one that climbs very high up the income scale.14
There is no denying that the price of a college education has increased, outpacing inflation for the past ten years. But rather than being the solution, regressive government subsidies could be part of the problem. Three main theories have been posited to explain rising prices:
Is Gofundme Taxable Income
So, the question are GoFundMe donations tax deductible has been answered, but what about those that are running the Fundraisers? Do you have to pay taxes on donations received from GoFundMe? Before deciding to set up a GoFundMe campaign, its completely reasonable to ask the question is GoFundMe taxable income, and most of the time, the answer is a yes, but it can depend on a few circumstances. Whats classed as taxable income is different in every country, so we cant say for certain for everyone, but for those asking is GoFundMe taxable in the US, its a no – unless your donations cant be considered as a gift.
Typically, the IRS considers donations to GoFundMe campaigns as personal gifts, which dont fall into the income category in the US – so is GoFundMe taxable in the US, you ask? If you can class the donations as a gift and theyre under $14,000, then no, you dont have to pay tax! To be able to class donations you have received as gifts, you cant give anything to your donors as this will look more like a payment for services, goods, or rewards, rather than a gift. This rule goes for all types of online fundraising, like Kickstarter, Indiegogo, and GoFundMe. Giving your donors some sort of item or service for their donation is classed as reward-based crowdfunding, which is taxable. You can read our Payroll and Income Tax Guide for further income tax information and guidelines.
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Is Contributing To A 529 College Savings Plan Worth It
If you dont get a federal or state tax deduction for 529 plan contributions, you may be wondering whether its even worth your time to open one. While missing out on a deduction for contributions isnt that great, the other tax benefits you can enjoy can make up for it. Tax-deferred growth and tax-free withdrawals can be a great incentive to save in a 529 plan versus parking money in a regular savings account or CDs.
When opening a 529 college savings plan, be sure to compare your states plan against those offered by other states. Specifically, consider the range of investment options offered, lifetime and annual contribution limits and any fees the plan may charge to find the one thats the best fit for your needs.
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:
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Your State’s Plan May Offer Additional Tax Benefits
If you are a resident or taxpayer of another state, you should consider whether that state offers a 529 plan with tax advantages or benefits that are not available through College Savings Iowa. Other state benefits may include financial aid, scholarship funds, and protection from creditors. Be sure to weigh all the pros and cons of a particular plan before you enroll.