The Tax Advantages of Using a 529 Savings Account in 2023

A 529 savings account is a type of investment account that is specifically designed to save for college expenses. Earnings […]

A 529 savings account is a type of investment account that is specifically designed to save for college expenses. Earnings on contributions grow tax-free, and withdrawals used to pay for qualified higher education expenses, such as tuition, fees, and room and board, are also tax-free. In addition, many states offer tax deductions or credits for contributions to a 529 plan. This can make a 529 plan a valuable tool for families saving for a child’s higher education expenses.

Are Contributions to a 529 Plan Pretax?

No, all contributions to a 529 savings account are post-tax. This means that the money has already been included in the contributor’s taxable income for the year in which it is contributed.

Are Contributions to a 529 Account Tax Deductible?

At the federal level, contributions to a 529 account are not tax-deductible. However, some states do offer tax deductions or credits for contributions to a 529 plan, which would help reduce your tax burden for that particular year.

Because any 529 investments grow tax-free, state and federal agencies have put limitations on how much you can contribute in the form of gift tax maximums. While there are no limits to what you can actually contribute to a student’s 529 savings account, anything over the annual gift tax maximum will trigger a tax on those gifts.

One limit is the annual contribution limit, which sets a maximum dollar amount that can be contributed as a gift to a person (i.e. student) in any given year. For example, parents can contribute up to $17,000 per year per person to a 529 plan in 2023 without incurring federal gift taxes, or $34,000 if the parents are married and filing jointly.

Do 529 Plans Grow Tax Free?

One of the main advantages of a 529 plan is that the investments in the account grow tax-free. This means that any interest, dividends, or capital gains earned on the investments within the account are not subject to federal income tax. This can result in significant savings over time, particularly if the account is invested in a manner that generates a high rate of return.

Another advantage of tax-free growth is that it allows more of the contributions to compound over time, potentially leading to a larger account balance at the time of withdrawal. This can make a significant difference in the amount of money available to pay for college expenses.

As an example, let’s say you contribute $2,000 per year to a 529 plan for 18 years and earn an average annual return of 6%. If the investments were subject to federal income tax at a rate of 20%, the account balance would be $63,872 at the end of 18 years. However, if the investments were tax-free, the account balance would be $71,908 at the end of 18 years.

Another example, if you contributed $50,000 at the start of 18 years and earn an average annual return of 8%. The account balance will be $155,581 if the investments were subject to federal income tax at a rate of 20% while the account balance would be $170,974 if the investments were tax-free.

Do 529 Contributions Get Reported on Tax Returns?

Unlike an IRA, contributions made into a 529 plan are not deductible and therefore do not have to be reported on federal income tax returns. Also, as the investments inside a 529 Savings Account grow, those earnings also do not become not reportable until the year they are withdrawn, and even then, only under certain circumstances.

Do 529 Distributions Get Reported on Tax Returns?

If 529 funds are used for qualified expenses and the amounts distributed are within the federal limits, then there will be nothing to report on your taxes, and nothing will be taxable. However, there are a few situations where you’ll need to report 529 distributions on your year-end taxes. 529 fund distributions only become taxable in the event of one or more of the following:

  • Unqualified expenses were paid for by the funds
  • Qualified expenses exceed the Adjusted Qualified Education Expenses (AQEE) 

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