Saving for Education: 529 Plans

Many parents are looking for ways to save for their child’s education. A 529 Plan through a Gilbert Tax Professional or accounting expert is an excellent way to do so. Thanks to the passage of tax reform legislation in 2017, 529 plans are now available to parents who wish to save for their child’s K-12 education, college or vocational school.

Anyone may open a Section 529 plan (in any state) with no income restrictions for the individual opening the account. Contributions, however, must be in cash and the total amount must not exceed what is reasonably needed for higher education (as determined initially by the state). There may also be a minimum investment required to open the account, typically, $25 or $50.


Each 529 Plan has a Designated Beneficiary (the future student) and an Account Owner. The account owner may be a parent or another person and typically is the principal contributor to the program. The account owner is also entitled to choose (as well as change) the designated beneficiary.

Neither the account owner or beneficiary may direct investments.  However, the state may allow the owner to select the type of investment fund (e.g., fixed income securities) and change the investment annually or when the beneficiary is changed. The account owner will choose the recipient of the funds and is legally allowed to withdraw funds, subject to tax and penalties (more about this below).

Unlike some of the other tax-favored higher education programs, such as the American Opportunity and Lifetime Learning Tax Credits, federal tax law doesn’t limit the beneficiary only to tuition. Room, board, lab fees, books, and supplies can also be purchased with funds from your 529 Savings Account. Individual state programs may have a more narrow definition so always be sure to check with your particular state.

Tax-free Distributions
Distributions from 529 plans are tax-free as long as they are used to pay qualified higher education expenses for a designated beneficiary. Distributions are tax-free even if the student is claiming the American Opportunity Credit, Lifetime Learning Credit, or tax-free treatment for a Section 530 Coverdell distribution–provided the programs aren’t covering the same specific expenses. Qualified expenses include tuition, required fees, books, supplies, equipment, and special needs services. For someone who is at least a half-time student, room and board also qualify.  Starting in 2018, “qualified higher education expenses” include up to $10,000 in annual expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school.

Note: Qualified expenses also include computers and related equipment used by a student while enrolled at an eligible educational institution.  However, software designed for sports, games, or hobbies does not qualify unless it is predominantly educational in nature.

Federal Tax Rules

Income Tax. Contributions made by the account owner or other contributors are not deductible for federal income tax purposes, but many states offer deductions or credits. Earnings on contributions grow tax-free while in the program. Distribution for a purpose other than qualified education is taxed to the one receiving the distribution. In addition, a 10 percent penalty must be imposed on the taxable portion of the distribution, comparable to the 10 percent penalty in Section 530 Coverdell plans. Also, the account owner may change the beneficiary designation from one to another in the same family. Funds in the account roll over tax-free for the benefit of the new beneficiary.

Gift Tax. For gift tax purposes, contributions are treated as completed gifts even though the account owner has the right to withdraw them – thus they qualify for the up-to-$15,000 annual gift tax exclusion. One contributing more than $15,000 may elect to treat the gift as made in equal installments over that year and the following four years, so that up to $75,000 can be given tax-free in the first year.

Estate Tax. Funds in the account at the designated beneficiary’s death are included in the beneficiary’s estate – another odd result, since those funds may not be available to pay the tax. Funds in the account at the account owner’s death are not included in the owner’s estate, except for a portion thereof where the gift tax exclusion installment election is made for gifts over $15,000. For example, if the account owner made the election for a gift of $75,000 in 2018, a part of that gift is included in the estate if he or she dies within five years.

Tip: A Section 529 program can be an especially attractive estate-planning move for grandparents. There are no income limits and the account owner can give up to $75,000 dollars.  They will also avoid gift and estate tax by living five years after the gift was given and have the power to change the beneficiary at any point in time.

State Tax. State tax rules are all over the map. Some reflect federal rules while others reflect different rules. For a specific state’s program, see

Professional Guidance
Considering the differences among state plans, the complexity of federal and state tax laws, and the dollar amounts at stake, please call the office and speak to a Gilbert Tax Professional and accounting professional before opening a 529 plan.

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