By Jake Fram, Tax Senior Associate and Sean Rutherford, Tax Associate
Update: Learn more about re-contributing 529 Plan refunds as a result of COVID-19.
Tax Savings for 529 Plans
Saving for education expense can be a daunting task, but a special tax code section, IRC Section 529 (Qualified Tuition Programs), helps by providing tax incentives to families and individuals looking to save. IRC Section 529 allows for special education savings accounts which are commonly referred to as “529 accounts” or “529 plans.” A 529 account can be a great tool in saving for education expense, providing both short- and long-term tax savings for those with the ability to allocate funds towards education before expenses are actually incurred. With the recent changes under the 2017 Tax Cuts and Jobs Act, this tool has only become more powerful. This article examines the benefits of the 529 accounts and highlights the opportunities for further tax savings, created by the new tax law.
- Contributions made to a 529 account are not deductible on your federal tax return, however Virginia allows a taxpayer a $4,000 PER ACCOUNT (not per child) deduction for contributions made to a Virginia 529 plan (if you are under age 70). If contributions to an account exceed $4,000 in a tax year, the excess deduction may be carried forward indefinitely and deducted annually on each VA tax return.
- Good news: There is no limit on the number of accounts that can be set up for beneficiaries. Also, if you are age 70 or older, you may deduct the entire amount contributed to the 529 account.
- Historically, 529 plans could only be used for higher education (college or graduate school). Funds invested in a 529 plan grow tax free on both the federal and State level and, if used towards qualified expenses, retain its tax free status upon distribution.
- In tax year 2018, under the 2017 Tax Cuts and Jobs Act, these incentives were extended to include up to $10,000 annually per student of elementary or secondary public, private or religious school expenses. The new law applies to distributions made in 2018.
- With the change from the new tax law, it may be tempting to withdraw funds currently in a 529 plan, previously set aside for college, to pay for primary or secondary education expenses. A more advisable strategy would be to instead contribute the money you would have used to pay for tuition to a VA529 plan. Following a required 5-business day wait period, these funds (up to $10,000 per year per student) are eligible to be distributed and used to pay the primary or secondary education expenses. With Virginia’s highest marginal tax rate of 5.75%, $10,000 of qualified expenses yield a $575 tax savings per child.
- The key to obtaining the full benefit is taking advantage of the fact that Virginia does not limit the number of accounts an individual may have in their name, as long as the total value of all the accounts does not exceed $500,000. Thus, by opening multiple accounts, even if those accounts are in the name of the same beneficiary and account owner, a taxpayer can take multiple $4,000 deductions.
- It is also advisable to contribute currently more than the $10,000 annual limit for primary or secondary school expenses to allow for such funds to grow on a tax free basis and ultimately be withdrawn on a tax free basis.
Administration of the withdrawal for primary or secondary education expenses
- Currently VA is not equipped to remit tuition payments directly to primary or secondary schools. The account holder should make a request for the $10,000 of education expense and VA529 will issue a check to the account holder who can then remit the payment to the school. VA529 is in the process of registering primary and secondary schools such that payment can be made directly to the school upon the request of the account holder. VA529 anticipates this registration process to take several months.
- You may setup an account for anyone’s benefit, including yourself, and change beneficiaries at any time. Contributions made to an account are deductible by the account owner, regardless of the beneficiary or the person making the donation.
- Grandparents and other relatives may also open a 529 plan in their resident state and may be eligible to claim the deduction on their own state return. Taxpayers should verify the state rules relating to 529 plan deductions in their specific state.
- When making contributions to 529 accounts, it is important to be aware of gift tax implications, since contributions are considered as being made to the beneficiary and not directly to the school. The 2018 annual exclusion gift to each beneficiary is $15,000. There is the possibility to split gifts among spouses and increase the annual exclusion gift to each beneficiary to $30,000. Also, there is a special election that can be made to allocate contributions to 529 plans over a 5 year period. This allows the prefunding of a 529 plan by making a contribution of $75,000 in one year ($150,000 if gift splitting). Please keep in mind that any other gifts made to that beneficiary over the 5 year period will utilize part of the donor’s lifetime exemption. The 2018 lifetime exemption is $11.2 million per taxpayer.
The expanded use of 529 plans for up to $10,000 annually per student for primary or secondary education expenses provides a tax advantaged savings option. The state tax deduction for the amount of the contribution is helpful, but the main benefit is the potentially tax free appreciation on the funds. Contributing sooner rather than later to allow for such tax deferred growth provides both federal and state tax savings. Keep in mind that you should not deplete the account originally intended to fund college and graduate school expenses, but rather route your normal primary or secondary expense payments through 529 plan accounts for the increased savings.
Additional Tax Planning Resources
- 4th Quarter Summary of Key Tax Developments for Businesses and Individuals
- New Tax Law: What You Need to Know
- Do your 2017 investments qualify for the Virginia Qualified Equity and Subordinated Debt Credit?
- Individual Tax Planning: Neighborhood Assistance Program (NAP) Credit Benefits
- The Tax Cut and Jobs Act: 4 Tax Changes Homeowners Need to Know
- Keiter Blog
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.