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Tax Laws on 529 College Savings Plans

Tax Laws on 529 College Savings Plans

529 state-run plans have always had tax benefits, but recent federal tax law changes have made them even more attractive to many families. Here's what you need to know to get the most out of the new rules.


Key Points to Note.

  • 529 plans can also be applied to pay off part of student loan debt, as well as for professional training costs.

  • 529 plans can now be used for Kindergarten to Grade 12 expenses, not just university and other post-secondary education types.

  • Federal tax laws passed in 2019 added several new tax benefits to 529 plans.


529 Plans Can Now Be Used For High Schools.

The Tax Cuts and Jobs Act (TCJA) of 2017 made several changes to 529 savings plans, the most common type of 529. (The other main type, prepaid monthly plans, are not only offered in several smaller states.). The new law extended 529 savings plans to cover primary and secondary education.

Previously, 529 plans were kept for post-secondary education. These expenses include tuition, accommodation and board, books, and other essentials. The withdrawals used for these eligible expenses were exempt from taxes.

Under the new law, parents now make tax-exempt withdrawals from a 529 account to pay for tuition at K-12 schools. However, these withdrawals are limited to $ 10,000 per year, while college tuition can be any amount required to cover eligible expenses. (Anything over is taxable.)


529 Plans vs. Coverdell Education Savings Accounts.

The K-12 move makes 529 plans similar to Coverdell Education Savings Accounts (ESA), which are less used. These accounts allow parents to save both college and elementary, high school, or high school expenses. However, a big difference is the parent contribution to 529 compared to an ESA Coverdell.

A Coverdell account prevents parents from saving $ 2,000 per year for their child or another eligible beneficiary until the beneficiary is 18.1 years old.

With a 529 plan, the contribution limits are much more generous. The IRS rules allow parents to contribute to a plan necessary to pay for the beneficiary's eligible educational expenses. According to the state, the plans set limits on increasing the balance, currently from $ 235,000 to over $ 500,000.

Another downside of Coverdell ESA is that not everyone can contribute. For 2019, only single taxpayers with adjusted gross adjusted income less than $ 110,000 and married couples with income less than $ 220,000 are eligible. There are no income restrictions for 529 plans. Finally, Coverdell's contributions are not tax-deductible, while 529 contributions enjoy a state tax deduction or credit in most states.


Transfer Funds From the 529 Plan to an ABLE Account.

The 2017 tax law also enables account holders to transfer 529 assets in an ABLE account to the same beneficiary or another family member, provided they do not exceed people with disabilities and can use the annual deposit limits on an ABLE account (15,000 $ in 2020). These tax benefit accounts without affecting their eligibility for certain benefits, such as Medicaid.


Paying Off Student Loans With a 529 Plan.

The SECURE Act, while focusing primarily on retirement, also made major changes to 529 rules.

On the one hand, the 529 income can now be used to pay off certain student loan debts of the account beneficiary or their siblings, up to a maximum of $ 10,000 per person. Previously, student debt did not count as an eligible expense.

529 funds can be used to pay off part of the student loan debt for both the account's beneficiary and the siblings.


Using a 529 Plan for Learning Expenses.

Another important change in 2019, 529 funds can now be used to pay for the fees, books, consumables, and equipment needed to participate in a learning program registered and certified by the Secretariat of Labor.


What Hasn't Changed?

In addition to these recent changes, the 529 regimes retain all of the previous tax benefits (and any penalties). Remember:

  • Change of beneficiary: You can swap a 529 plan beneficiary with another family member without paying tax.

  • Increase in deferred taxes: The money in your 529 accounts will grow and accumulate deferred taxes, both state and federal, until you withdraw it.

  • No federal deductions or credits: Unlike several states, the federal government does not offer income tax deductions or credit for 529 contributions.

  • Statement of loans and deductions: Over 30 states offer tax deductions or state loans if you live in that state and contribute to any of your 529 plans. Seven states (Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana, and Pennsylvania) also offer tax incentives if you invest in another state's plan. 

  • Taxes on nonqualified withdrawals: If you make withdrawals for purposes other than qualifying educational expenses, you will have to pay income tax on the portion representing your investment income, but not your contributions. In many instances, you also owe a 10% penalty tax. 

  • Tax-free withdrawals: Any withdrawal you make will be tax-exempt if you use them for qualifying educational expenses. In the case of 529 savings plans, this includes tuition, accommodation, board, and other mandatory expenses. Prepaid tuition plans are limited to tuition fees.

  • The federal tax implications on donations: Although there is no limit to the amount you can contribute to a 529 plan each year, any contribution over $ 15,000 may result in federal donation taxes. If you have three kids with three 529 savings plans, for instance, you can give them $ 15,000 each, without tax on donations. Couples who file jointly can double this amount per child. Grandparents and other members of the family can also contribute to the same amount. To contribute even more without activating the donation tax, you can advance 529, contributing up to five years ($ 75,000) at the same time, if you can afford it. You won't make additional contributions to the plan until five years have passed, but the money will have more time to benefit from membership and grow faster.


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