Section 529 plans are investment accounts for education expenses. Contributions are made with after-tax dollars and aren’t federally tax-deductible. Some states offer deductions. Money in a 529 plan grows tax-free and withdrawals are tax-free if used for qualified education expenses.
Qualified expenses include tuition, fees, books, and certain room and board costs for eligible institutions. The Tax Cuts and Jobs Act expanded qualified expenses to include up to $10,000 per year per beneficiary for K-12 tuition at public, private, or religious schools.
Withdrawals not for qualified education expenses are subject to federal income tax and a 10% penalty. Exceptions to the penalty include scholarships and disability.
529 plans offer flexibility for the beneficiary. The beneficiary can change at any time to another eligible family member without penalty, and funds can be rolled over to another 529 plan for the same or a different beneficiary.
Section 529 plans and the annual gift exclusion
Contributions can exceed the annual gift tax exclusion. Moreover, a special election allows individuals to contribute up to five times the annual exclusion in a single year without triggering gift tax.
The annual gift tax exclusion is $16,000 in 2023. This means an individual could contribute up to $80,000 to a 529 plan for a beneficiary without incurring gift tax. This is true as long as they don’t make additional gifts for five years.
Check state rules for deductions. Some states offer full or partial deductions for contributions to their state’s 529 plan, while others offer none.
Keep track of which expenses are qualified education expenses. So, if a withdrawal is made for non-qualified expenses, the earnings portion will be subject to federal income tax and the 10% penalty.
If a beneficiary receives tax-free educational assistance for the same expenses, they must include the 529 plan distribution as income on their tax return.
529 plans can help save for future education expenses and enjoy tax benefits. Finallly, it is important to understand the rules and regulations surrounding contributions and distributions to make the most of these plans.