By: Ryan Wisniewski
When it comes time to start saving for college for a child or other beneficiary, other than beginning early, the most important recommendation is to take advantage of what Internal Revenue Code Section 529 has to offer.
Internal Revenue Code Section 529 allows savings accounts to be established in which account owners contribute funds to an account to pay for a beneficiaries’ education expenses. Account owners can contribute up to amounts set by individual states. For example, Connecticut allows contributions of up to $300,000 and New York allows contributions of up to $520,000 for all accounts held for the same beneficiary. Once the aggregate account balances reach a total value in excess of these limits, contributions can no longer be made. While there are no Federal tax deductions related to contributions to a 529 account, many states do offer tax deductions. For example, Connecticut and New York both offer up to a maximum deduction of $10,000 per year for Married Filing Joint filers ($5,000 for Single).
The funds contributed to and the related earnings of a 529 College Savings Plan grow Federal and State tax-free and are distributed Federal and State tax-free, as long as they are used to pay for qualified education expenses.
Qualified education expenses include higher education expenses, summarized below:
- Tuition, fees, books, supplies, and equipment for attendance.
- Expenses for special needs services related to attendance.
- Room and board, limited to the greater of the allowance for financial aid purposes or the actual cost of campus housing.
- Cost of computer, peripheral equipment, software, and internet access.
- Up to a maximum amount of $10,000 of student loan principal or interest per beneficiary and sibling.
Qualified education expenses also include expenses related to K-12 enrollment or attendance at any public, private, or religious school, limited to $10,000 per beneficiary per year.
Qualified expenses do not include expenses that were paid for with tax-free assistance (For example: scholarships, grants, or other assistance) or those expenses used to calculate any education credits or deductions.
IMPORTANT! If you are income eligible for certain education credits or deductions, be sure that you pay enough education expenses out-of-pocket, using non-529 College Savings Plan account dollars, to maximize your allowable benefits.
IMPORTANT! If you will need to fund college expenses out-of-pocket, and you did not contribute to a 529 plan during the year, consider contributing at least the state deductible amount. You can then turn around and distribute the funds to pay for those college expenses. While you might not earn any income on the amount contributed, due to the short-duration that the funds were in the account, you will at least receive up to a $10,000 state tax deduction (in regards to CT and NY; other states may vary) and all it cost you was some time to transfer funds around.
529 plans can be an effective way to save for anyone’s future education costs. Understanding who can contribute to an account, and the other rules about ownership, could help you maximize your potential benefits and potentially reach your savings goal faster. Consult an R+R tax advisor to assess your situation and determine the best way to proceed.
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