|Britt Erica Tunick is an award winning financial journalist who has spent the past 17 years writing about virtually every aspect of finance. She has mastered the art of boiling down complicated financial topics for readers to understand.|
Tax Benefits of 529 Savings Plans
By Britt Erica Tunick
If you have kids, you are more than likely to have 529 savings plans set up for them. 529 plans are incredibly popular, given that the earnings they generate are free from federal taxation, and usually state taxation as well, as long as they are used to pay for higher education costs for the beneficiary the account was opened for, or a student in the same family. And, while there aren’t any federal tax deductions for contributions to 529 plans, depending on the state you live in, you may be able to get state tax deductions or credits for the annual contributions you make.
There are currently 34 states and the District of Columbia that allow residents to take state tax deductions full or partial, depending on the state, as long as the 529 plan contributed to is run by that state. Taxpayers who live in Arizona, Kansas, Maine, Missouri, Montana or Pennsylvania are actually eligible for state tax deductions for the money they contribute to any 529 plan, even if the plan is not run by the state within which they live.
Given the large number of 529 plans that exist, such benefits are definitely something to take into consideration. You should also consider the performance record of each fund, as well as the type and amount of fees each plan charges. The best 529 plan for you may not necessarily be the one run within your own state, so it definitely pays to do a bit of research.
And since benefits such as state tax breaks don’t end the second your child enters college, if you live in a state that provides tax breaks for 529 contributions you may still want to open an account even if you turn around and withdraw your contributions just a few months later (just be sure to read the fine print and make sure there isn’t a set waiting period before contributions can be withdrawn). That’s because people who live in states that allow for tax breaks on 529 contributions are eligible for such tax breaks as long as a child’s higher education costs have not already been paid for. Though such late-stage contributions will not benefit from the compounded interest that long-term 529 investments do, as long as the management fees that you pay in association with your contributions aren’t higher than the tax breaks you will get, it may be worth it.
With the enactment of the Tax Cuts and Jobs Act at the end of 2017, the definition of “higher education costs” for federal tax law purposes was changed to include tuition paid not just to colleges, but also to private elementary and secondary schools. To find out whether the state you live in has conformed their definition to federal law, or allows for 529 contribution tax breaks, check with your state taxing agency or your accountant or financial advisor.
Read other How to Invest and Save Money articles