By: Salvatore Amato, CPA
For many of us, the holiday season brings the opportunity to share joy and presents with our families and friends. Gift giving, while fun and exciting, can also pose its challenges. Well-intended toys and games just add to the growing stockpile many children have, and there is always the difficulty of finding the “hot toy” of the season, if you don’t hit the stores early. This year, consider a contribution to a 529 college savings plan for a special child. Their parents, your tax bill, and, one day, the child, will thank you for it.
Higher education costs are ever-rising and getting an early start on saving is one way to ensure a financial advantage. Contributing to a 529 plan also lessens the impact on the environment associated with production and distribution of physical gifts, while simultaneously teaching a lesson on investing for the future.
A 529 plan will grow tax free over time, and distributions will not be taxed, provided the funds are used to pay for qualified higher education expenses, vocational school, K-12 tuition, or apprenticeship fees and expenses. Qualified higher education expenses include tuition and fees, room, and board (provided you are enrolled at least half-time), books and computers or computer equipment for the student’s use. If the funds are used for something other than qualified education expenses, income tax, plus a 10% penalty, will be charged only on the earnings portion. Certain education tax benefits, including credits, set a maximum income limit to qualify, meaning not all families can take advantage, while 529 plans do not have this restriction. You qualify for federal tax breaks on 529 earnings regardless of income level.
Many 529 plans make gifting easy by offering gifting platforms that accept online contributions, which can easily be shared with friends and family in the form of a personalized code, Gift of College gift cards, or Evites, in addition to the traditional contribution by check. If the child does not have a 529 account, it is easy to open one in their name. One of the benefits to opening an account is that you stay in control of the account, and the named beneficiary has no legal rights to the funds in a 529 account, so you can assure the money will be used for its intended purpose. You can withdraw funds at any time for any reason, but keep in mind that the earnings portion of non-qualified withdrawals will incur income tax and an additional 10% penalty tax.
Contributions of a sizeable amount can be made to a child’s 529 plan without incurring gift taxes. Gifts of up to $15,000 per beneficiary (for 2021) qualify for the benefit of the annual gift tax exclusion. Those wishing to make a larger tax-free gift can take advantage of five-year gift tax averaging. This means gifts up to $75,000 can be treated as if they are spread evenly over a five-year period. Both benefits are per gift giver; therefore, couples can gift up to $30,000 per year per child, or $150,000 if using five-year gift tax averaging.
Tax deduction rules vary from state to state, so be aware of the specifics for your state before investing. Also, depending on the state, some deductions are only available to the owner of the account, so it may be in everyone’s best interest to open an additional account so that you can qualify for the deduction. There is no limit to the amount of 529 accounts that can be opened for one beneficiary. Here are a few examples:
- Pennsylvania allows you to deduct up to $15,000 per beneficiary, per year. Married couples can deduct up to $30,000 per beneficiary, per year, provided each spouse has taxable income of at least $15,000.
- Maryland’s 529 savings plans allow you to deduct up to $2,500 of gifts annually per beneficiary.
- New Jersey currently does not allow any deductions, but the 529 plan tax deduction is part of a comprehensive college affordability plan in the state’s fiscal year 2022 budget proposal. The proposal would allow a deduction of up to $10,000 per year from state taxable income. The benefit would only be available to households with an annual income of $200,000 or less.
During the holidays, any thoughtful gift is always appreciated, so why not look ahead and make a smart choice that will benefit all. Talk to your tax and investment advisors about how you and the beneficiary can benefit from 529 accounts.