If you’re planning for your child or grandchild’s college education, a 529 plan might be your answer. These tax-advantaged plans, named for the Internal Revenue Code section that provides for them, help you prepay for higher education costs, setting them up for success.
There are two types of qualified tuition programs:
- Prepaid plans. Lock in current tuition rates by buying tuition credits or certificates, even if the student is years away from college.
- Savings plans. These depend on the performance of the fund(s) you invest your contributions in.
What are the tax benefits?
While 529 contributions aren’t federally tax-deductible, the earnings grow tax-free and some states offer tax deductions for contributors too. You can even change the beneficiary or roll funds over to another plan without triggering tax consequences.
Distributions are tax-free—up to the amount of the student’s qualified higher education expenses—for tuition (up to $10,000 for elementary or secondary public, private, or religious schools), fees, books, supplies, and equipment. Room and board qualify too, if the student is enrolled at least half-time.
You can also use tax-free withdrawals to pay the principal or interest on loans related to higher education for the beneficiary or their sibling.
If you use 529 plan funds for non-education expenses, you will have to pay taxes on the earnings. Plus, the IRS will charge a 10% penalty on that extra amount so it’s best to stick to qualified expenses.
Your contributions to a 529 plan are considered gifts to the student, but they qualify for the gift tax exclusion ($18,000 in 2024, adjusted for inflation). If your contributions exceed this limit, you can spread the excess amount out over five years starting with the year of the contributions.
For 2024, if you make no other gifts to that beneficiary, you can contribute up to $90,000 per beneficiary without incurring a gift tax. If you’re married, you and your spouse can contribute $180,000 per beneficiary, subject to plan limits.
If you contribute more than the allowed amount in one year, any extra contributions in the next four years could be taxed. However, if the gift tax exclusion limit goes up in those years, you might be able to contribute more without paying taxes.
Which schools qualify?
Eligible institutions include colleges, universities, and vocational schools that participate in U.S. Department of Education student aid programs—including most accredited public, nonprofit, and for-profit schools.
Qualified expenses can also include elementary or secondary public, private, or religious school tuition. Check with your school to confirm if it qualifies.
Tax-smart education
Distributions from a qualified tuition program aren't subject to gift tax, but changing beneficiaries or rolling over funds could trigger it. Get in touch with your Smolin advisor to learn more tax-efficient college savings strategies.