A Section 529 plan is a great way to save for a child’s higher education. You can put money in an account for your child and watch it grow without any current tax erosion until the child is ready to go to school. Then any distributions from the account are exempt from tax if they are used to pay for qualified expenses like tuition.
But Section 529 plans don’t have to be used only for your kids. One can be set up to reward virtually any beneficiary—including yourself!
Let’s briefly recap the key tax rules. For starters, there are three main income tax breaks for Section 529 plans.
1. Tax-favored contributions: No federal income tax results from contributions made to a Section 529 account. Plus, you may be eligible for deductions or other tax incentives on the state level.
2. Tax-deferred accumulation: The amounts contributed to the 529 account grow and compound without any current tax ersiosion. There are no tax consequences until amounts are withdawn.
3. Tax-free distributions: There is no federal or state income tax imposed on distributons used to pay for qualified expenses Typically, this includes tuition, fees, books, supplies and equipment needed for school, plus room-and-board for students who are enrolled at least half-time. Other distributions are taxable at ordinary income rates.
So let’s say you’re thinking of going back to school. Maybe you want to complete your college degree or enroll in a graduate school or another advanced level of study. You can establish the 529 plan and name yourself as beneficiary. Then you may reap the tax rewards as described above.
What’s more, if you still have funds left in your account after you’ve finished your schooling, you can roll over the plan assets tax-free to a different beneficiary, like a child or a grandchild. Or, depending on the situation, the account might have initially been set up for a child and it can be switched to a parent. Of course, you can then add contributions to pay for higher education expenses in the future.
Mote: Contributions are subject to federal gift tax, but may be sheltered by the annual gift tax exclusion. For 2023, a taxpayer can give away up to $17,000 a year—$34,000 for joints gifts by a married couple—to an account for the beneficiary without any gift tax. Even better, the tax law allows you to give the equivalent of five years worth of contributions up-front with zero gift tax consequences. The gift is treated as if it were spread out over the five-year period.
When you finally empty out the 529 account, the remainder is subject to income tax. Plan ahead to avoid any adverse tax consequences. Your professional advisors can lend a helping hand.
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Tags: Income Tax, IRS, Taxes
