529 college savings plans: Are 529 contributions tax deductible?
At a glance
529 contributions are tax deductible on the state level in some states. They are not tax deductible on the federal level. But if you’re saving for college, you’ll want to know that 529 savings plans offer other tax benefits, such as tax-free earnings growth and tax-free withdrawals for qualified expenses. These tax-savings vehicles might change your vision of tuition plans being out of financial reach!
Whether you’re a parent dreaming of a college education for your kids, or you’re an adult setting your sights on higher ed, you’re probably already thinking about the costs or financial aid. Luckily, a 529 college savings plan is an option that helps you save for college – and has a tax benefit. Follow along as we explain the deductions you may be eligible for when you make contributions, the 529 qualified expenses you can take when it’s time to pay for school, as well as other key tax advantages and implications.
What is a 529 plan?
A 529 plan is a type of account that features certain tax benefits and is especially designed for saving for and paying for college and other qualified higher education. Think of it as a Roth IRA or mutual fund of sorts. The difference between common individual savings plans and 529s is that the plan fund exclusively is used for educational expenses.
Examples include apprenticeship programs, vocational schools, and other postsecondary learning institutions eligible to participate in the federal student aid program administered by the United States Department of Education. Plus, coverage includes elementary or secondary private schools (think K-12 tuition), religious schools, and even student loan repayments – advancing the opportunity to leverage tax savings in other areas.
Are 529 contributions tax deductible?
If college is in your or your loved ones’ futures, you’re probably wondering if 529 contributions tax are deductible. And for a good reason: It’s essential to understand what you can deduct when you direct plan funds!
In short, 529 contributions are not tax deductible on the federal level. However, some states consider contributions tax deductible. (Defer to your state treasurer for more info!)
Plus, 529 plans offer other tax benefits. Earnings from the direct plans aren’t subject to federal income tax and generally not subject to state income tax when used for qualified education expenses. In essence, the earnings on your contributions can grow tax-free over time.
As you review your 529 plan options, be sure to check the deductibility rules for your state.
529 college savings plans: Distributions and recontributions
When it’s time to take money out of your 529 to pay for higher education expenses (called a distribution or withdrawal), you’ll want to understand the tax implications.
First, any earnings withdrawn are excluded from a student’s taxable income. In addition, some states allow contributions to be excluded from your state tax bill.
The Internal Revenue Code states the taxation of 529 depends on how you use it. Below, we’ll define and expound on distributions and recontributions.
Because 529s are built to be used for certain college expenses, a 10% penalty will apply to the earnings portion if you take the money out for other purposes. (This is on top of the normal tax on the earnings.) That said, it’s important to know what expenses meet the rules and which don’t. If the expenses meet the rules, the distribution is considered qualified.
When you take funds out of your 529 Plan, you won’t need to pay federal or state taxes on the distribution as long as you use the withdrawal for qualified education expenses. In addition, you don’t incur a tax penalty if you use the funds right away for an acceptable expense.(For some people, you might take a distribution that is partially taxable only if a part of it is used on qualifying expenses.)
What are 529 qualified expenses?
529 qualified higher education expenses generally include:
- Computer technology or equipment
- Room and board
- Tuition plans
A word of caution for those claiming the American Opportunity Tax Credit (AOTC): You can claim this credit the same year that you have a 529 distribution. But, here’s what you need to watch out for: You can’t use the same expenses for the AOTC that you’ve paid for with your 529 money. For example, if you paid tuition with your 529, you wouldn’t use that expense to claim the AOTC. Long story short, there’s a rule against double dipping using the same expenses for the AOTC & 529 money.
Have other related tax filing questions? Make sure to visit our Tax Guide for College Students and reference other college student tax credits.
With 529 plans, you might come across the term “recontributions.” It’s when your school issues a refund for expenses paid with a 529 plan, and you recontribute it back to the plan (to the same beneficiary) within 60 days to avoid paying taxes or incurring a tax penalty. The PATH Act of 2015 added a special rule for the recontribution of 529 refunds.
What else should you know about recontributions?
When you put the refunded money back into your plan, it must be equal to or less than the refund amount. If you put back more than what you originally contributed, it’s considered a new contribution. Also, because recontributions part of your principal, they don’t count towards your plan’s maximum contribution.
How do I report 529 withdrawals?
Do you need to report 529 activity on your taxes each year? The short answer: it depends.
Scenario 1: If you’re not withdrawing from your account, you don’t need to report it on your income taxes.
Scenario 2: If you take a 529 distribution, the 529 plan administrator will send Form 1099-Q by Jan. 31 the next year. Suppose the funds were used on a qualified education expense or rolled over to another 529 plan. In that case, you don’t need to report anything on your taxes. But, if you take a distribution and use it for an unqualified expense, it counts as a taxable withdrawal. It will be subject to federal (and sometimes state) taxes.
Get expert tax guidance on 529 plans today
With a bit of planning, you can use educational savings plans to pay for school smarter (like avoiding excessive student loans) and offset taxes.
To review your own options, learn about all the ways to file with H&R Block. For state income tax guidance – like finding out if there’s a state tax deduction for 529 contributions – learn more about our state tax filing software.
You could also reach out to a financial advisor for personalized guidance in building a unique college investing plan.
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