529 Plan Tax Consequences

Individuals are allowed to save money for higher-education expenses via tax-advantaged investments called 529 plans. Originally introduced in 1996, 529s are now available in every state. These are either prepaid tuition plans, where individuals pay for future college expenses at today's rates or college savings plans, where money is invested for future college expenses.

State Tax Deductions

Of the 42 states that collect income tax, 35 provide tax incentives for contributions to 529 plans. Some offer the advantage as a deduction and others offer it as a credit.

Federal Taxes

No federal tax deductions are allowed for contributions to 529 plans.

Growth of Contributions

The contributions are allowed to grow tax-free for as long as the money remains in the account.

Withdrawals

As long as the money is withdrawn for qualifying educational expenses, withdrawals are tax-free. Qualifying educational expenses include tuition, fees and supplies. For students attending school at least half time, room and board is also a qualifying expense.

Penalties

Withdrawals not used for qualifying educational expenses are subjected to a 10 percent penalty, in addition to state and federal taxes.

References

• Saving for College: What Is a 529 Plan?