Parents contribute to 529 college savings plans (529 plans) for future college expenses of their kids.Section 529 plans have no income limits, age limits or annual contribution limits.Further , you can change your 529 savings plan investment options twice per calendar year. This post is to bring four major tax issues that one should note when investing in 529 college savings plan.
Distribution from 529 plans are tax free
Distributions from a 529 college savings plan are tax-free if used to pay for qualified education expenses subject to certain additional restrictions.
What does qualified higher education expenses mean ?
It means the expense that are natural for person attending college education . So it includes
- tuition fees,
- equipment, and
- expenses for special-needs services required for enrollment or attendance.
- room and board expense If enrolled on at least a half-time basis restricted to room and board allowances specified by the educational institution
The distribution from 529 plans is called Qualified Distribution if the distribution was for the beneficiary for whom plan was taken and distribution was used for qualified expenses.
If a distribution is not a qualified distribution , then such distribution from 529 plans will have tax consequences as under :
- The earnings portion of a non-qualified distribution will be taxed at the beneficiary’s rate
- In addition to the tax , a 10 percent tax penalty.
- The portion of a distribution that comes from contributions is not taxed.
Gift Tax on Contribution to 529 Savings Plans
The contributions to a 529 college savings plan may be subject to gift taxes. The annual exclusion for each gift for 2017 is $14,000 and for 2018, the annual exclusion is $15,000.
If the contribution exceeds the annual gift tax exclusion, excess will suffer gift tax. This treats the contribution as having been made proportionately over a five-year period beginning with the current tax year. If the contributor dies during the five-year period, the portion of the gift corresponding to periods after the death of the contributor will remain in the contributor’s estate. For example, if an your uncle gives $40,000 to 529 College Savings Plan related to his nephew, it will be treated as if he gave $8,000 per year for five years. If he dies during the second year, $16,000 will be excluded from his estate and $24,000 will be included as your income.
529 plans by State Gives Tax Benefits
If you invest in following state’s 529 savings plan , you may get income tax deduction.
- Alabama, Arizona, Arkansas, Colorado, Connecticut, Georgia, Idaho, Illinois, Iowa, Kansas, Louisiana, Maine, Maryland, Michigan, Mississippi, Missouri, Montana, Nebraska, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, Virginia, Washington DC, West Virginia and Wisconsin.
- 4 states (Colorado, New Mexico, South Carolina and West Virginia) allow a deduction for the full amount of the contribution to the state’s 529 plan
- 3 states- Indiana, Utah and Vermont, provide a state income tax credit.
- 6 states -Arizona, Kansas, Maine, Missouri, Montana and Pennsylvania- provide a tax deduction for contributions to any state’s 529 plan.
You can read IRS FAQs on 529 college savings plan here