Plans Arent Just For College
While 529 plans are generally associated with university education, they can also be used for private primary and secondary schools, too. So, if youre paying tuition for grades K-12, you can take advantage of a 529 plan, too. The expansion of the program came about as part of the 2017 Tax Cuts and Jobs Act.
The new rules also allow for the use of 529 plan distributions in apprenticeship programs. Apprenticeships are now considered a qualified higher education expense if the apprenticeship is registered and certified with the U.S. Department of Labor.
Get A State Income Tax Deduction
If you’re a New York State taxpayer and an account owner, you may be able to deduct up to $5,000 of your Direct Plan contributions when you file your state income taxes. Please consult your tax advisor. **
You must make a contribution before the end of a given calendar year for it to be deductible for that calendar year. If you send your contribution by U.S. mail and it’s postmarked on or before December 31, we’ll treat your contribution as having been made in the year in which it was sent.
To learn more about depositing your tax refund directly to your NY529 Direct Plan account, see here.
Note: There are no federal tax deductions for contributions to 529 plans.
There Are No Federal 529 Plan Tax Deductions
While 529s are similar to 401s, the tax advantages and rules are not identical.
One major difference is that, unlike a 401, you cannot get federal 529 tax deductions for your contributions to this account. While certain 401 and individual retirement accounts offer the chance to save for retirement in pretax dollars, theres no correlating federal tax benefit for 529 accounts.
Withdraw Earnings Without Being Taxed
No taxes are due to the federal government, or to most states, when money is withdrawn from a 529 account and applied to qualified expenses. And the list of what and where an expense counts as qualified is bigger than you might think. 529s can actually be used by almost anyone to pay for a host of education-related expenses.
529 Plan account owners can withdrawal assets to pay for K-122 tuition up to $10,000 per year per beneficiary. Always consult a tax professional K-12 withdrawals may be subject to specific state taxes.
How To Get Started With A 529 Plan
It can be easy to open a 529 plan, and you can start a 529 directly through a specific states plan or through a broker. You can start a plan with any state, but before you open one, youll need to do some research.
Before choosing a 529, investors will want to evaluate a 529s investment options to see how these investments have performed, says Van Sant.
Be sure to look at what investment options are available and how much they cost. Good investment options allow you to maximize your potential return and minimize your costs.
Additionally, investors will need to compare and contrast investing in their own states 529 plan versus investing in another states 529, as there are typically tax advantages associated with investing in ones home state 529, says Van Sant.
Once you determine which 529 is best for you, setup and funding is rather seamless, says Van Sant.
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Plan Tax Benefit And Advantages
Regardless of how much you invest, these tax advantages help you maximize your college savings:
- Tax-Deferred Growth Contributions grow free of federal and state income taxes while in the account.
- Tax-Free 529 Withdrawals No income tax is paid on the growth of your account when withdrawals are used for qualified expenses.
- State Tax Deduction Deduct your contributions from your taxable income. Check with your state for specific tax benefits. For example, Kansas taxpayers receive an annual adjusted gross income deduction of up to $3,000 for contributions per child. The availability of tax or other state benefits may be conditioned on meeting certain requirements, such as residency, purpose for or timing of distributions, or other factors.
- Estate Planning & Accelerated Gifting Reduce your personal taxable estate through accelerated gifting . This means you can make five years’ worth of gifts up to $80,000 to your 529 account in a single year without being subject to gift taxes. This benefit is unique to 529 plans.
The difference between tax-free growth and taxable growth can be significant. Using these tax benefits means you are putting your money to work for you!
The availability of tax or other state benefits may be conditioned on meeting certain requirements, such as residency, purpose for or timing of distributions, or other factors.
How To Incorporate Potential Tax Benefits When Deciding Which Plan To Choose
Fifteen states do not offer state-specific tax incentives, either because it’s a state with no income tax or a state that doesn’t offer any tax benefits on 529 contributions. These investors, along with those who reside in tax-parity states, have the flexibility to shop around, as they can invest in any plan without forfeiting tax benefits. Morningstar Analyst Ratings can point these investors to the best options. Currently, 14 plans receive an Analyst Rating of Gold or Silver, listed in Exhibit 4. Subscribers to Morningstar.com can access our 529 plan reports from the 529 Plan Center map. .
For those who reside in states with specific tax benefits, the exhibits below provide factors and data points to consider when selecting a plan. First, we list the Analyst Rating for the lowest-cost direct-sold plan and the average fees for the plan’s cheapest age-based or target-date enrollment series, typically the default choice for most 529 plan users. We then return to our couple earning $100,000. The dollar value from a $3,000 contribution is listed in the second and third exhibits above. In the tables below, we calculate the maximum tax benefit by contributing at the state’s limit, per year, per beneficiary. These calculations, along with the state’s tax deduction or tax credit basis , can help families estimate the potential tax savings for their situation .
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Tools To Shape Your 529
Ohios 529 Plan offers tools and calculators to help you shape the college saving account that best fits the needs of your family. Our College Savings Planner can help you determine what dollar amount you would like to set aside to reach your college savings goal. The Cost of Waiting Tool can show how starting early with your higher education savings can really build up, even if its a small contribution to start. The Tax Benefit Tool illustrates how the tax-free earnings in a 529 plan allow you to keep every dollar that grows in the account, unlike a taxable bank savings account. Lastly, when youre ready to open an Ohios 529 Plan account, take the Risk Tolerance Questionnaire to determine which investment style conservative, moderate, or aggressive you are most comfortable following.
This list offers many reasons to save in a tax-free 529. Ohios 529 college savings plan is a simple way to save for any higher education goal and its accepted nationwide. There is no fee to open an Ohio 529 Plan and the minimum contribution is only $25. The minimum contribution to open a Fifth Third 529 CD, at any term, is $500.
This article was originally posted in February 2020 and has been updated to reflect new information for 2022.
Posted on February 07, 2022
Ohio Tuition Trust Authority
These Plans Are Low Maintenance
A 529 plan is a very hands-off way to save for education. To enroll, simply visit our Best 529 Plans page and select the plan you like best or contact your financial advisor.
Most plans allow you to set it and forget it with automatic investments that link to your bank account or payroll deduction plans. The ongoing investment management of the account is handled by an outside investment company hired as the program manager or by the state treasurers office.
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S: A Handout To The Upper Middle Class
Who reaps the benefits of these tax breaks? The main beneficiaries are upper-middle-class families. The Government Accountability Office found that in 2010, 47 percent of families with 529 plans had an annual income of over $150,000. 4 The tax benefits associated with 529 plans also skew towards higher-income families, according to the GAO. The median tax savings for families making up to $100,000 was $561, compared to $1,958 for families making between $100,001 and $150,000, and $3,132 for families with incomes over $150,000.
Carryforward Of Excess 529 Plan Contributions
Ohio is also one of 12 states that allow taxpayers to carryforward excess 529 plan contributions to deduct in future tax years. That means if the grandparents want to contribute more than Ohios annual limit of $4,000 per beneficiary, they may deduct the excess in future years in increments of $4,000 per year, until the entire contribution amount is deducted.
You Can Use 529 Plan Contributions To Reduce Your Taxable Estate
There are generous limits for 529 plan contributions to be seen as gifts for tax purposes. In 2022, deposits to a 529 plan up to $16,000 per individual per year will qualify for the annual gift tax exclusion.
Those looking to reduce estate taxes can elect to treat a 529 plan contribution of between $16,000 and $80,000 as if it were made over a five calendar-year period to qualify for the annual gift tax exclusion. This type of accelerated gifting will reduce your personal taxable estate and is unique to 529 plans.
Avoid Issues With 529 Plan Withdrawal Timing
The account owner gets to decide when to withdraw funds from a 529 plan. Some plans have a waiting period before you can take a distribution. For instance, you cant make a contribution on day one and then take a distribution on day two.
A logical assumption is that a 529 distribution must be requested when the college bill is received and then used to pay the balance due. In reality, a distribution can be taken at any time during the year, and it is tax-free as long as an amount equal to or greater than the qualifying expenses are paid during the year. In other words, the distribution doesnt have to be traceable to the actual payment of expenses.
A problem occurs when you withdraw money from a 529 plan this year, and wait until next year before making the tuition payment or, if you paid the expenses last year with a personal check and you reimburse yourself this year by taking a 529 plan withdrawal. By spanning two tax years, you are risking a mismatch that can result in tax and penalties.
The risk of a mismatch is especially high when the second semester tuition bills arrive in December but arent payable until January.
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Coordination With American Opportunity And Lifetime Learning Credits
An American opportunity or lifetime learning credit can be claimed in the same year the Beneficiary takes a tax-free distribution from a qualified tuition program as long as the same expenses arent used for both benefits. This means that after the beneficiary reduces qualified education expenses by tax-free educational assistance, he or she must further reduce them by the expenses taken into account in determining the credit.
Plan Benefits: They Grow Tax
Earnings on 529 accounts are not treated as taxable income. Lets say, for example, that you save $1,000 in a 529 investment account, which grows by 5% in a year to $1,050. That $50 in growth isnt taxable.
Plus, if you sold those 529 account investments to pay for your childs college, you wouldnt face federal income tax on the sale proceeds or account withdrawals as long as you use those funds to pay for qualified education-related expenses. But if you use 529 funds for nonqualified expenses, the earnings could be taxed as income. Other penalties might apply too.
The rules for spending 529 funds allow you to use the money for everything from tuition to paying for a students internet access. The Secure Act, which became law in 2019, further relaxed rules on how you use money in a 529 plan. It allows beneficiaries of 529 funds to use leftover money to repay up to $10,000 of their student loans. The law also lets borrowers apply money from their 529 plan to pay for home schooling expenses and apprenticeships as well as private primary and secondary education.
No matter the expenses that the 529 money goes toward, growing college funds in a 529 savings account without adding to your tax burden is a significant tax benefit.
How Much Does A 529 Plan Cost
States often charge a one-time account setup fee for a 529 plan. These have ranged from as little as $25 to $964 for the lowest-cost option. In addition, if you bought your 529 plan through a broker or advisor, they may charge you as much as 5% or more on the assets under management. The individual investments and funds that you have inside of your 529 may also charge ongoing fees. Look for low-cost mutual funds and ETFs to keep management fees low.
You Stay In Control Of Your Account
With few exceptions, the named beneficiary has no legal rights to the funds in a 529 account, so you can assure the money will be used for its intended purpose. This differs from custodial accounts under UGMA/UTMA, where the child takes control of the assets once he or she reaches legal age.
A 529 account owner can withdraw funds at any time for any reason but keep in mind that the earnings portion of non-qualified withdrawals will incur income tax and an additional 10% penalty tax.
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Plans Owned By Grandparents Or Anyone Else
- Assets arent counted on the Free Application for Federal Student Aid ? Assets held in a 529 account owned by a grandparent, other relative or anyone else besides a dependent student or one of their parents will have no effect on the students FAFSA.
- How are distributions treated? When a grandparent withdraws the funds to pay for their grandchilds college expenses, it will be counted as student income on the FAFSA. Student income is assessed at 50%, which means if a grandparent pays $5,000 of college costs it would reduce the students eligibility for aid by $2,500. Remember, higher EFC means less financial aid. One strategy to avoid this problem: if the student will graduate in four years, they can wait to contribute until after the students third semester of college, since the FAFSA looks at income from two years prior.
Nonqualified Withdrawals Are Taxable Income
To determine the nontaxable portion of a nonqualified withdrawal, multiply the distribution by the ratio of total contributions over the account balance on the last day of the calendar year.
The person who receives the distribution will receive a Form 1099-Q with the earnings reported in Box 2. That person must report taxable earnings on Line 21 of his or her 1040 and use Form 5329 to calculate the penalty.
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Plans Are Low Maintenance Investment Accounts
A 529 plan account can be opened online or through a licensed financial advisor. Families who prefer to set it and forget it can select an automatic investment plan linked to a bank account or payroll deduction plan. The ongoing investment management within a 529 plan is handled by the program manager.
The Cost Of 529 Plans Is Set To Rise
As 529 plans mature and more families use them to fund college costs, the price tag to the U.S. Treasury will also rise, unless some reforms are undertaken. Over the next decade, the federal government is set to spend almost $30 billion on 529 tax expenditures, according to Treasurys Office of Tax Analysis. Annual costs are projects to be just under $4 billion by 2026.
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How To Open And Contribute To A 529 Plan
Parents, grandparents and other family members can open a 529 account on behalf of a child or adult at a brokerage or other financial institution, or directly with a state. A person can be the beneficiary of more than one 529 plan at the same time, but you’ll want to make sure the combined contributions don’t exceed the state’s contribution limit.
Most 529 college savings plans allow you to open an account with a small amountsay $25 or $50 a monthif you sign up for an automatic investing plan, with the 529 contributions coming directly from your bank or brokerage account.
Also, be sure to ask whether your employer allows you to make 529 contributions automatically as a payroll deduction, which is a benefit some companies offer.
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