Benefits of Contributing to a 529 Plan

by Jay Holmes

I admit – often in the accounting profession we can toss around acronyms and short-hand and think that everyone else around us immediately understands what we’re talking about. It’s a fault of all professions, but particularly in accounting because there are so many abbreviated terms.

This week we’re diving into the short-hand of 529 Plans.

When we say 529 Plan, we are talking about a particular type of savings and investment plan operated by a state or financial institution that has tax advantages to make it easier to save for college or other post-secondary training for a beneficiary of your choosing.

Whew, that’s a long sentence!

So let’s unpack it.

The main tax advantage of putting money into a 529 college savings plan is that the earnings from your contributions grow tax-free. The initial contribution to the plan is not deductible on your federal return, but when the money is withdrawn to pay for qualified education expenses, no tax is due on that money. The sooner the money is deposited in the account, for, say, your two-year-old niece, the longer the money has to grow, and the more “tax-free” money you accumulate in earnings.

A beneficiary can be anyone, including yourself. You can set up a plan to benefit a friend, a relative, a co-worker, and yes, even yourself. You can set up as many plans as you’d like, and your contributions are not restricted based on how much money you make.

529 Plans have a caution, though. A person cannot make unlimited contributions to the plan and have exponential tax-free growth. There is no formal limit to the dollar-amount of contributions, but it cannot exceed the amount necessary to provide for the beneficiary’s qualified education expenses. And, be wary of any gift-tax consequences for amounts greater than $14,000 contributed in one year (2016 limit).

The second caution is that if funds are withdrawn for a purpose other than qualified education expenses, then the earnings are subject to income tax plus a 10% withdrawal penalty on the earnings.

The State of Idaho offers a 529 Plan with a slight modification: in addition to tax-free earnings for qualified education expenses, contributions are deductible on your state income tax return. The plan needs to be established with the IDeal college savings program and set up by 12/31/16 to count for the current tax year. And deductible contributions are limited to $4,000 per person contributing ($8,000 married).

As you can see, there’s a lot behind the short-hand term 529 Plan. Give us a call if you have questions about how this affects your personal tax situation. And, you can check out these links for more information:

IDeal College Savings Program IRS.Gov