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Understanding the 529 Plan Rules

Understanding the 529 Plan Rules

There are several college savings plans with 529 plans as one of them. It comes with a series of tax benefits and can allow you to build your kid's college funds with time. In addition, this plan has the advantage of growing tax-free, and your withdrawals will not be taxed as well, provided you use them for education expenses that qualify.

This article sheds light on how citizens can maximize their 529 plans, benefit, and avoid pitfalls.

 

Tax Rule for 529 Plans 

If funds from your 529 plans were not used for expenses that qualify, such as tuition fee, such withdrawal is termed unqualified. As a result, the portion of your withdrawal that you earn will be subjected to income tax alongside a 10% penalty. You might even have to return any tax deductions you claimed on contributions alongside state income tax. 

The tax penalty for states on non qualified withdrawals is a factor of the laws of the state. As a result, make sure to contact a CPA or tax professional such as ROSOVICH & ASSOCIATES, INC. to understand the impact of an unqualified withdrawal, fully. 

However, the bright side is that you can withdraw from your contribution without penalty and limitations since the contributions were an after-tax dollar.

 

State Rules for 529 Plans 

Unknown to many people, it is not compulsory to enroll in the 529 plans sponsored by your state of residence. Also, your kid need not be schooling at a college explicitly located in the sponsoring state. Provided you are a US citizen, resident alien, you have a tax ID number or valid social security number, you can open a 529 account. 

With this, it is possible to open an account in Texas for someone living in California who might eventually go to school in Miami. States, which sponsor their 529 plans, do have their contribution limits that differ over the country.

 

Tax Rules for 529 plans and Gifts 

An important thing to know about 529 plans is that the FG treats such contributions as gifts directed to the recipient for tax. Thus, any contribution above $15,000 will trigger a gift tax, while married couples filing jointly will trigger a gift tax should they contribute above $30,000. 

However, some exceptions with 529 plans is that singles can contribute up to $75,000 while married couples can contribute double every year for a 529 plan provided they don’t contribute again in the next five years. This rule applies the gift tax exclusion for the five years. With this, assume that you contribute $60,000 in a year; Uncle Sam treats this as $12,000 contributed for five years. Thus, you will not even incur gift tax if you contributed $22,500 over the coming four years.


Withdrawal Rules for 529 Plans 

The idea of a 529 plan does not appeal to some people as higher education expenses that qualify seem challenging to understand. However, here are some examples of such expenses:

  • Compulsory fees and tuition at qualified schools like universities, grad schools, and community colleges.

  • Room & Board expenses are directly paid to the school for any student enrolled for half the term.

  • Room and board off-campus for any student enrolled half the time provided the fee is not above estimated living cost on campus.

  • Essential school supplies and books compulsory for enrollment 

Here are some examples of expenses that are not qualified:

  • Cost of transporting yourself to and from campus

  • Medical expenses you incur at college with the college insurance 

  • Health club membership on campus 

  • Fees and other dues paid for clubs sponsored by the school

With this, make sure to reach out to the financial aid office in your child's school to have an idea of all expenses in a particular calendar year and know if such expenses qualify.

Also, Uncle Sam needs to be aware of all 529 plan activities like withdrawals, making it compulsory to report it in tax time using form 1099Q.


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