The education savings plan known as the 529 Plan or Qualified Tuitions Plan has been set up to help students and parents set aside money for college. It can be used for education from qualified colleges across the U.S. It will also make you eligible for special tax benefits that are provided by the federal tax law.
Let’s look at a few of the state and federal tax benefits of 529 plans.
1. Earnings grow tax-free and withdrawals to pay for college are not taxed provided, you MUST use it to cover your college expenses only (Read point 4).
2. Contributions to a 529 tax plan stand to gain full or partial tax deductions in at least 33 states. You don’t have to report these contributions on your federal tax returns. As you can claim benefits for each contribution, continuing this until all tuition fees are cleared may be helpful.
3. Income tax benefits can be availed even if it is not an in-state 529 Plan if you are in a tax parity state.
4. You don’t have to pay federal income taxes on distributions IF the money is used for qualified education expenses. This covers tuition, board, and books as well as other supplies. However, state income tax will vary based on states. If it is a non-qualified withdrawal, there will be a penalty and regular tax laws will apply.
5. Federal gift tax is waived off on annual contributions to college savings plan. The amount for gift tax exclusion is $14,000 per year or $28,000 for a married couple.
6. It does not affect a student’s eligibility for FAFSA as only up to 5.64 percent of parental assets are considered in the Expected Family Contribution (EFC). Low EFC means more financial aid.
7. If the person for whom the 529 Plan was intended gets a scholarship, the beneficiary can be changed to another family member. In such cases, the change is not taxable.
By starting early and continuing with regular contributions, and availing the combined benefits of federal and state tax deductions, a 529 Plan can prove to be an advantage.