If you have a child or grandchild planning to attend college, you may have heard of qualified tuition programs, or 529 plans. Named after the Internal Revenue Code section that governs them, these plans allow you to prepay higher education costs with tax advantages.
Two Types of 529 Plans
Prepaid Plans: Lock in today’s tuition rates by purchasing tuition credits for future use.
Savings Plans: Invest your contributions in funds, with growth depending on fund performance.
Tax-Free Growth
While 529 plan contributions aren’t deductible on federal income taxes, account earnings grow tax-free. Some states also offer tax deductions on contributions. You can change the beneficiary or roll over funds to another 529 plan for the same or a different beneficiary without tax penalties.
Qualified Tax-Free Distributions
Funds from a 529 plan can be withdrawn tax-free for “qualified higher education expenses,” including tuition (up to $10,000 for K-12 public, private, or religious schools), fees, books, supplies, and necessary equipment. Room and board are also qualified if the student is at least a half-time student. Additionally, tax-free distributions can cover principal or interest on a student loan for the beneficiary or a sibling.
Non-Qualified Distributions: If you withdraw more than the qualified expenses, the excess earnings are taxed to the beneficiary, with an additional 10% penalty tax.
Gift Tax Considerations
529 contributions count as gifts to the student but qualify for the annual gift tax exclusion ($18,000 in 2024). If contributions exceed this limit, you can spread the amount over five years to maximize tax benefits. This allows up to $90,000 per beneficiary in 2024 ($180,000 for married couples), without triggering gift tax, if no further gifts are made to that beneficiary over the next four years.
School Eligibility
529 plans cover most colleges, universities, vocational, and other postsecondary institutions that participate in U.S. Department of Education programs. Qualified expenses can also include K-12 tuition for public, private, or religious schools. Schools can verify if they qualify.
Smart Education Savings
Distributions from a 529 plan are not subject to gift tax, but changes in beneficiary or plan rollovers might be. Contact us with questions about tax-efficient strategies to save and pay for education.