When it comes to securing a quality education, the costs can sometimes feel overwhelming. That’s where 529 plans shine as beacons of financial relief. These versatile savings options provide not only a smart way to set aside funds for higher learning but also pack a powerful punch in terms of tax benefits. If you’re eager to learn how to harness the full potential of 529 plans while gaining insights into their tax-efficient nature, you’ve come to the right place.
What are 529 plans?
Also known as qualified tuition programs, these plans enable prepayment of higher education costs on a tax-favored basis.
Types of 529 Tuition Plans
Prepaid 529 Plans
These plans allow you to buy tuition credits or certificates at present tuition rates, even though the beneficiary (child) won’t be starting college for some time.
Savings Plans
The 529 savings plans depend on the investment performance of the fund(s) you place your contributions in.
- You don’t get a federal income tax deduction for the contribution
- Earnings on the account aren’t taxed while the funds are in the program.
- You can change the beneficiary or roll over the funds in the program to another plan for the same or a different beneficiary without income tax consequences.
Tax-Free Distributions for Qualified Education Expenses
Distributions from the program are tax-free up to the amount of the student’s qualified higher education expenses.
Qualified higher education expenses include:
- Tuition (including up to $10,000 in tuition for an elementary or secondary public, private, or religious school)
- Fees, books, supplies, and required equipment
- Reasonable room and board is also a qualified expense if the student is enrolled at least half-time.
Distributions in excess of qualified expenses are taxed to the beneficiary to the extent that they represent earnings on the account. A 10% penalty tax is also imposed.
Eligible Schools
Eligible schools include colleges, universities, vocational schools, or other postsecondary schools eligible to participate in a student aid program of the Department of Education.
This includes nearly all accredited public, nonprofit, and proprietary (for-profit) postsecondary institutions.
However, qualified higher education expenses also include expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school.
Contributions to 529 Plans
The contributions you make to the qualified tuition program are treated as gifts to the student, but the contributions qualify for the gift tax exclusion amount ($15,000 for 2020, adjusted annually for inflation).
If your contributions in a year exceed the exclusion amount, you can elect to take ratable contributions into account over a five-year period, starting with the year of the contributions.
Thus, assuming you make no other gifts to that beneficiary, you could contribute up to $75,000 per beneficiary in 2020 without gift tax. (In that case, any additional contributions during the next four years would be subject to gift tax, except to the extent that the exclusion amount increases.)
You and your spouse together could contribute $150,000 for 2020 per beneficiary, subject to any contribution limits imposed by the plan.
A distribution from a qualified tuition program isn’t subject to gift tax, but a change in beneficiary or rollover to the account of a new beneficiary may be.
So, there you have it—the scoop on 529 plans and their tax perks. By now, you’re armed with the knowledge to make your education savings work smarter, not harder. Keep these insights in your back pocket as you navigate the world of tuition and taxes, ensuring you’re well-prepared to give your loved ones the best shot at success.
More Information
If you have questions, contact us to discuss your situation.
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James Curran
James Curran works with individuals and businesses and is passionate about getting to know his clients and their goals, both personal and professional. He spends time with them, helping to identify and solve their most pressing questions and concerns.
About Smith Patrick CPAs
Smith Patrick CPAs is a boutique, St. Louis-based, CPA firm dedicated to providing personal guidance on taxes, investment advice and financial service to forward-thinking businesses and financially active individuals. For over 30 years, our firm has focused on providing excellent service to business owners and high-net worth families across the country. Investment Advisory Services are offered through Wealth Management, LLC, a Registered Investment Advisor.