If you are saving for college, it’s important to have information about making 529 contributions that can maximize available state tax breaks. So, here are a few reminders to help you take advantage of tax benefits associated with your 529 college savings plan — beginning with a quick overview of how 529 plans work.
How do 529 plans work?
A 529 plan is a state-sponsored, tax-advantaged college savings investment plan. When you enroll in a 529 plan, the money you invest grows on a tax-deferred basis. When you withdraw from the 529 plan and use the money to pay for qualified education expenses, those withdrawals are tax-free.
529 plans are designed to encourage saving for college and typically cover qualified education-related expenses like tuition, fees, books, computers, and other supplies. Certain room and board expenses are usually considered to be “qualified expenses.” But sometimes, whether 529 college savings can be used to pay for the cost of room and board will depend on whether those costs exceed certain amounts.
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Additionally, 529 plan funds can generally be used to pay tuition for professional and trade schools and up to $10,000 per student, per year, can be used to pay for K-12 private school tuition. In any case, keep in mind that each 529 plans may have its own specific rules regarding what particular expenses are considered to be "qualified expenses."
Do you get a tax break for contributing to a 529 plan?
A 529 plan doesn’t offer a federal income tax benefit because 529 plans are state-sponsored. As a result, the contributions to your 529 plan are not tax deductible on your federal tax return. However, some states offer a state tax credit or tax deduction for 529 college savings plan contributions made in your home state.
As previously mentioned, your 529 plan funds grow tax-free, and withdrawals of 529 college savings account funds that are spent on qualified expenses are also tax-free.
But remember: If you withdraw 529 plan funds and don’t use that money for qualified education-related expenses, you could face a 10% federal income tax penalty.
How late can I contribute to a 529 plan?
In most states, you should contribute to your 529 college savings plan by the end of the year, i.e., December 31, to maximize any state tax breaks associated with those contributions.
But in other states, you can contribute until that state’s tax filing deadline next year. (The specific deadlines vary by state). For example, some states that don’t have a year-end contribution deadline for maximizing 529 plan contribution benefits are Iowa, Georgia, Mississippi, Oklahoma, South Carolina, and Wisconsin.
In all cases, and because you are not limited to choosing a 529 plan from your home state, it’s important to know which 529 plan contribution deadlines apply to you. Check your 529 plan rules or talk with a professional tax advisor who may be able to help you maximize your state tax benefits.
How much can I contribute to a college 529 plan in 2023?
Note that 529 college savings plans do not have set individual annual contribution limits like 401(k) plans do. Instead, annual and aggregate contribution limits for 529 plans vary by state.
It’s also important to keep in mind that contributions to your 529 plan are treated as gifts for federal income tax purposes. Under the 2023 gift tax exclusion, you can contribute up to $17,000 tax-free per donor. However, gifts over $17,000 must be reported on a federal gift tax return. That doesn’t necessarily mean you will be taxed on your gift since the lifetime federal gift tax exemption amount is high.
What if my child doesn’t go to college?
From a tax perspective, if your student doesn’t attend college and you withdraw 529 college savings plan funds for other than qualified education-related expenses, then the money you take out of the 529 plan would be subject to the 10% federal income tax penalty.
Additionally, the 529 plan funds you withdraw for non-education-related expenses, would be considered taxable income — which could impact your federal and state taxes.
529 plans: What you can do
Because so much about 529 plans varies by plan and by state, you should familiarize yourself with the specific rules governing your plan.
Also, consult a qualified financial planner or other trusted advisor if you are uncertain about those rules or about how to get the most tax benefit from your 529 college savings plan.
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