The 529 plan is one of the popular ways to save for college, with most states offering at least one option. With a 529 plan, your college savings grow without federal tax on withdrawals for qualified higher education expenses. Qualified higher education expenses also include tuition fees for private or religious education from kindergarten through 12th grade.
Key Takeaways
529 plans or Qualified Education Programs (QEPs) are specialized savings accounts designed to help pay for future students’ higher education expenses. Contributions to 529 plans are subject to federal gift tax limits, which can be set annually. The tax treatment of 529 plans varies by the state offering the plan, whether through deductions, credits, a combination of both, or neither. It is important to remember that 529 plans are investment accounts that differ in performance and risk. Choose a plan that fits your needs.
Federal Deductions for 529 Plans
There is no federal deduction for contributions to a 529 account. At the federal level, contributors should keep in mind that contributions may be subject to federal gift tax rules. In 2022, you could give up to $16,000 to someone before incurring gift tax, or $32,000 for married couples who combine gifts. The maximum is $17,000 ($34,000 for married couples filing jointly) in 2023.
Top Tax Benefits of Available 529 Plans
More than 30 states offer a tax deduction that allows taxpayers to receive a tax benefit on contributions to 529 plans. Three states offer tax credits. Seven states provide tax parity on contributions to other states’ plans. States that offer tax benefits, tax deductions, tax parity, and tax credits are clear favorites for the best benefits.
Tax Parity
There are seven states that provide their residents with tax parity for contributions to 529 plans from any state, not just their own. These states include: Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana, and Pennsylvania. This allows residents of these states the freedom to choose state plans – looking for those with the lowest fees and best investment options – while still receiving a state tax deduction.
Tax Credits
The states of Indiana, Utah, and Vermont offer tax credits, which include the following:
- Indiana: Any contributor can claim a tax credit of 20% on contributions up to $5,000 for a tax credit of up to $1,000.
- Utah: Contributors can claim a tax credit of 4.85% per beneficiary on contributions up to $2,130 (for individual filers) or $4,260 (for those filing jointly) for a tax credit of up to $103.30 (for individuals) or $206.61 (for couples) for 2022.
- Vermont: Contributors can claim a tax credit of 10% per beneficiary on contributions up to $2,500 (for individual filers) or $5,000 (for those filing jointly) for a tax credit of up to $250 (for individuals) or $500 (for couples).
Tax Deductions
Regarding the remaining states that provide tax savings, you can deduct the contributed amounts in the state plan where deductions are available. Thus, the best tax states will be those that offer the largest deductions.
While most states set monetary limits on deductions in 529 plans, Colorado, New Mexico, South Carolina, and West Virginia allow the full amount of contributions in their relevant 529 plans to be deducted. However, Colorado limits deduction amounts to an individual’s adjusted gross income capped at $20,000 for individuals and $30,000 for joint filers.
States
States That Do Not Offer Tax Savings
There are some states that do not offer a tax deduction or credit for 529 plan contributions. If you reside in one of these states, there are still many 529 plan options available, but there are no tax reductions to benefit from. If you live in one of these states, your best option is to choose a state plan with low fees and provides some type of investment options you prefer. In most cases, you do not need to be a resident of a state to invest in its plan.
Although you do not receive direct tax deductions from your state for contributing to a 529 plan, you will benefit from federal tax advantages in the future as long as you withdraw from it appropriately.
Which State Plan Should You Choose?
Deductions and tax credits are great, but they may not add much if your state’s 529 plan has high fees. Be sure to check the fees associated with your state plan (and whether they waive those fees for state residents). Shop around and compare those fees with those available in other states. Other important aspects include investment performance and whether the plan includes investment options like target-date funds.
Is There a Federal Tax Benefit for Contributing to 529 Plans?
There is no tax credit or deduction at the federal level for contributing to a 529 plan, but this type of savings account is tax-advantaged, as earnings from 529 plans are not subject to federal tax when used for qualified educational expenses.
Are There Any Drawbacks to Using a 529 Plan?
Like any investment, there are always risks. 529 plans can be structured in various ways, so you can mitigate the risk of losing any of your initial investment by selecting the option that aligns with your financial situation and your student’s future. If you use the earnings for anything other than qualified higher education expenses, they will be subject to federal taxes.
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Source: https://www.thebalancemoney.com/best-states-for-college-savers-3193238
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