If you have a child or grandchild planning to attend college, you've likely heard about 529 plans—qualified tuition programs designed to help prepay higher education costs in a tax-advantaged way.
Two Types of 529 Plans
- Prepaid plans allow you to lock in tuition at today's rates for a future beneficiary (your child or grandchild), even if they won't be starting college for several years.
- Savings plans depend on the performance of the fund(s) you invest in.
Tax Advantages of 529 Plans
While contributions to a 529 plan are not deductible for federal income tax purposes, earnings grow tax-free while the funds remain in the plan. Some states do offer state income tax deductions for contributions. Plus, you can change the beneficiary or rollover funds to another 529 plan without any income tax consequences.
When it's time to withdraw funds, distributions are tax-free up to the amount of the beneficiary's "qualified higher education expenses." These expenses include tuition, fees, books, supplies, and required equipment. Reasonable room and board costs are also eligible if the student is enrolled at least half-time. Tax-free 529 distributions can also be used to pay off student loans for the beneficiary or a sibling.
What Happens if You Exceed Qualified Expenses?
If you withdraw more than the qualified expenses, the excess is taxed to the beneficiary as income, and the IRS will impose a 10% penalty on the earnings.
Contributions and Gift Tax Exclusion
Contributions to a 529 plan are treated as gifts to the student, but they qualify for the gift tax exclusion (up to $18,000 per recipient in 2024). If you exceed this amount, you can elect to spread your contributions over five years without triggering gift taxes. You could contribute up to $90,000 per beneficiary in 2024 (or $180,000 for married couples) without incurring gift tax.
Eligible Schools
529 plan funds can be used at accredited colleges, universities, vocational schools, and elementary and secondary public, private, or religious schools for tuition expenses. Be sure to verify with the school to confirm it qualifies.
Tax-Smart College Savings
A distribution from a 529 plan isn't subject to gift tax, but be cautious of changes in beneficiaries or plan rollovers, which may trigger gift tax consequences. For more information on how to use 529 plans for tax-smart college savings, contact Brinker Simpson today. We're here to guide you in making the most of your education savings.
