Navigating 529 tax considerations

Navigating 529 tax considerations

Saving for education is one of the most important parts of securing a bright future for your loved ones. 529 savings plans offer a tax-advantaged way to invest in your child's education, but understanding the tax implications of contributions and withdrawals may be crucial for maximizing the benefits. With tax season upon us, let’s explore some key tax considerations for owners of 529 accounts.

The main attraction of 529 plans is their potential for tax-free growth. So long as the funds in the account are used for qualified education expenses, any earnings generated within the account are not subject to federal income tax and are generally not subject to state tax. This tax-free compounding is a powerful way to grow educational funds.

Contributions to a 529 plan aren’t federally tax deductible, so you don’t need to include them on your federal tax return unless you contributed more than the annual gift tax exclusion of $18,000 per person, or $36,000 for a married couple filing jointly. The IRS also allows "accelerated gifting" to a 529 plan, making up to five years of the annual gift tax exclusions in one year. This allows an individual to take advantage of as much as $90,000 in annual exclusions (or $180,000 for a married couple filing jointly) to shelter a larger contribution. This may be an attractive option for those looking to reduce the size of their taxable estate.

In addition to federal tax benefits, most states offer tax incentives to residents who contribute to their state's 529 plan, whether or not they are the account owner. These incentives may include deductions or credits on state income taxes. Keep in mind that in certain states, only the 529 plan account owner (or the account owner’s spouse) may claim a state income tax benefit. To maximize your savings, it's essential to research and understand state-specific 529 tax benefits. Check out our tax benefits by state page to see if your contribution is deductible.

It's also crucial to understand the tax treatment of 529 plan distributions. Qualified distributions—payments towards tuition, fees, books, and room and board at eligible institutions— are those that are not subject to federal taxes on earnings. Qualified higher education expenses will also, in most states, include up to $10,000 in annual expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school.

By understanding the tax considerations outlined above, you can make informed decisions to potentially maximize the benefits of your 529 plan. Regularly reviewing your investment strategy, staying up to date about changes in tax laws, and consulting with a financial professional will help you navigate the complexities of 529 plans and secure a strong foundation for your loved ones' educational pursuits.

Learn more about how to contribute to a child’s education with a 529 college savings plan.