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How a 529 plan affects your taxes

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A 529 plan is one of the most popular ways for parents to save for their child’s education. With these plans, any money you contribute can grow tax-free, and money can be withdrawn without penalty for education-related expenses. If you’re saving money for your child’s education, here’s how a 529 plan could affect your tax returns and possibly your savings in the future.

What are the tax benefits of a 529 plan?

The main tax benefit of a 529 plan is that you can grow your contributions tax-free, and any withdrawals are also tax-free as long as you use them for qualifying education expenses.

You may also be able to take advantage of tax deductions with your 529 plan. Contributions to your 529 plan aren’t tax deductible at the federal level, but some states offer a tax deduction for contributions.

How much of a 529 plan is tax deductible?

There are no federal tax deductions for 529 plans. However, if you’re in one of the many states that offers a tax deduction or credit for 529 plan contributions, you might get an additional incentive. States may offer deductions of up to $10,000 if you’re a single filer and up to $30,000 if you’re filing jointly, though each state has different rules and limits. Some states don’t offer any kind of tax deduction.

Do I have to pay taxes on 529 plan earnings?

All earnings on 529 plans grow tax-free. This means that the more contributions you make, the more opportunity you have to build your child’s 529 plan without paying taxes on it. In general, 529 plan balances can grow until you hit five years’ worth of expected education costs, though each state’s plan has its own limits.

You also won’t need to pay taxes on most withdrawals. As long as you use withdrawals to pay for things like tuition, fees, housing, books and supplies, you won’t be taxed; only if you use the money for nonqualified expenses will you be taxed and subject to a 10 percent penalty.

Reporting a 529 plan on your taxes

It’s not required for you to report 529 plan contributions on your federal tax return. However, you’ll need to report them on your state taxes if your state has income tax. You’ll also need to report any withdrawals that were not used for qualified educational expenses.

Most states allow you to take a deduction if you invest in a plan offered by that state. But a handful of states offer a deduction regardless of where the plan is from: Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana and Pennsylvania. This means that you don’t need to live in the state where the plan is offered to take advantage of a tax deduction.

Tax benefits are usually available to anyone who contributes to a 529 plan, including parents, grandparents and anyone else who contributes to an account.

Because of gift tax laws, you will also need to complete form 709 when doing your taxes if you contribute more than $16,000 each year to a 529 plan. However, you won’t necessarily be taxed on amounts exceeding $16,000; those amounts will simply count against your lifetime gift and estate tax exemption, which currently sits at $12.06 million.

The bottom line

Saving for your child’s education through a 529 plan is one way to help them lower the burden of borrowing money through student loans. While it’s not required for you to fund your child’s education, you’re doing them a service by contributing to a 529 plan early and often.

But don’t just set it and forget it. Maximize all of the different ways a 529 plan can give you tax benefits, including tax-free earnings and potential tax deductions. Your child might reap the biggest financial benefits of the plan, but you’ll get to take advantage of tax benefits. This means more money toward your child’s education.

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Written by
Dori Zinn
Contributing writer
Dori Zinn has been a personal finance journalist for more than a decade. Aside from her work for Bankrate, her bylines have appeared on CNET, Yahoo Finance, MSN Money, Wirecutter, Quartz, Inc. and more. She loves helping people learn about money, specializing in topics like investing, real estate, borrowing money and financial literacy.
Edited by
Student loans editor