When Can You Take a 529 Deduction?
Key facts
- There are no federal taxes assessed on 529 plan distributions as long as funds are used for the beneficiary’s qualified expenses at eligible institutions.
- If 529 distributions meet the federal tax requirements, they are typically exempt from state taxes as well.
- Contributions are not tax-deductible on your federal tax returns, but they may be deductible on your state returns.
Saving for college in a regular investment account subjects your earnings to income taxes. Many families find that the tax advantages of a 529 plan are a better option for growing their savings quickly. As the costs of higher education continue to rise, every little bit helps to ensure your student’s future expenses are covered.
529 Tax Deduction Guidelines
While you cannot deduct 529 contributions from your federal income taxes, earnings on the amount invested are free of federal taxes. As long as any distributions are used to pay qualified education-related expenses at an eligible institution, no taxes are incurred when you withdraw funds from the account.
Because each state administers its own 529 program, state-specific tax benefits vary. A recent review of 529 plans in all 50 states and Washington, D.C. showed that a majority permit taxpayers to deduct some or all of their 529 contributions. States typically do not require participants to be residents, but generally, you must be a resident to enjoy state-specific tax benefits. However, a handful of states offer tax parity, including Arizona, Kansas, Maine, Missouri, Montana and Pennsylvania. Residents of these states enjoy home state tax advantages for contributions made to any state’s 529 plan. For example, a resident of Maine might decide that Alaska’s 529 College Savings Plan offers the best fit for her investment goals. Contributions made to her Alaska 529 account are eligible for the same Maine state income tax deduction as contributions made to one of Maine’s 529 plan accounts.
Taking a 529 Deduction
There is no need to report contributions to a 529 plan on your federal taxes, and you won’t receive a tax form for your 529 plan earnings. However, state tax deductions can be a little more difficult to navigate. There are many variations on state-specific tax regulations. Some allow a portion of your contribution to be deducted, some allow all of it to be deducted, and some offer no benefit at all.
Between states, there can be nuances to who can deduct contributions. Examine your plan documents carefully, as well as the 529 information for your state, to gather complete details on the state-specific regulations that apply to your situation.
Disclosure
Nothing in this article should be construed as tax advice, a solicitation or offer, or recommendation, to buy or sell any security. This article is not intended as investment advice, and Wealthfront does not represent in any manner that the circumstances described herein will result in any particular outcome. Financial advisory services are only provided to investors who become Wealthfront clients.
This article is not intended as tax advice, and Wealthfront does not represent in any manner that the outcomes described herein will result in any particular tax consequence. Prospective investors should confer with their personal tax advisors regarding the tax consequences based on their particular circumstances. Wealthfront assumes no responsibility for the tax consequences to any investor of any transaction. Investors and their personal tax advisors are responsible for how the transactions in an account are reported to the IRS or any other taxing authority.
For information on any 529 college savings plan contact the plan provider for details on the investment objectives, risks, charges, expenses, and other important information included in the Plan Description and Participation Agreement; read and consider it carefully before investing.
Please Note: Before investing in any 529 plan, you should consider whether you or the beneficiary’s home state offers a 529 plan that provides its taxpayers with favorable state tax and other benefits that are only available through investment in the home state’s 529 plan. You also should consult your financial, tax, or other advisor to learn more about how state-based benefits (or any limitations) would apply to your specific circumstances. You also may wish to contact directly your home state’s 529 plan(s), or any other 529 plan, to learn more about those plans’ features, benefits and limitations. Keep in mind that state-based benefits should be one of many appropriately weighted factors to be considered when making an investment decision.
Earnings on nonqualified withdrawals are subject to federal income tax and may be subject to a 10 percent federal tax penalty, as well as state and local income taxes. The availability of tax and other benefits may be contingent on meeting other requirements.