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The Gift-Tax Benefits of ‘529’ Plans
Contributions to these state-sponsored education plans are considered gifts for tax purposes, up to a certain amount
Many individual investors know that “529” plans are a good tax-advantaged vehicle that parents and grandparents use to save for a child’s education.
What may be less well-known is that gift-tax rules can help families realize the full benefits of contributing to these plans, which can be used for college costs, as well as some K-12 education expenses.
“More people are becoming aware of this now,” says Mark Kantrowitz, a college-savings specialist in Skokie, Ill. “In some ways, a 529 is better than an IRA because many states also offer a tax deduction or credit with a 529.”
The 529 basics: These state-sponsored education plans, named after a section of the Internal Revenue Code, were created in 1996. Funds deposited in 529 plans are invested in mutual funds and exchange-traded funds on a federal after-tax basis. Earnings aren’t taxed when withdrawn if used for qualified educational expenses for a beneficiary. Such expenses include tuition, books, computers, internet access, supplies, equipment and fees. For college students enrolled at least half time, they can also include room and board. For K-12 students, the only allowable expense is up to $10,000 in tuition.
Gift-tax exclusion
One of the benefits of using a 529 plan for college savings is that contributions to these plans are considered gifts for tax purposes. In 2021, that means you can contribute up to $15,000 per beneficiary ($30,000 per married couple) to a 529 plan without having to pay gift taxes. If you set up more than one 529 plan this year, you can contribute up to $15,000 to each without having to file a gift-tax return.
Even if you contribute more than $15,000 to a 529 plan in a calendar year, you still might not have to pay a gift tax because the excess can count against the lifetime estate and gift-tax exemption of $11.7 million. These excess amounts must be reported on Internal Revenue Service Form 709.
Another nuance with gift-tax laws is that you have the option of “superfunding” a 529 plan, using five-year gift-tax averaging. That means you can make a lump-sum contribution of up to five times the annual gift-tax exclusion, or $75,000 this year, in a 529 plan without paying gift taxes and treat it as though it were spread over five years. Again, Form 709 must be filed.
Although there are no annual contribution limits to 529 plans, there are maximum aggregate limits ranging from $235,000 to $550,000, depending on the state. These maximum limits represent a state’s estimate of the full cost of attending college or graduate school in that state.
Once you’ve reached the maximum amount, you can’t put more funds into a 529 account, although the account can continue to earn a return on its investments. But if the market declines and the account balance shrinks, you can contribute more up to the state limit.
Other tax benefits
In addition to the benefits stemming from the federal gift-tax exclusion, many states offer tax benefits on 529 plans, as well. Thirty-four states and the District of Columbia let individuals take a tax deduction or credit up to a certain limit.
For instance, a New York plan allows contributions of up to $5,000 annually per taxpayer ($10,000 per married couple) to be deducted from the state’s taxable income. Some states even offer tax parity, whereby they give tax benefits to residents who contribute to another state’s 529 plan.
“Deductions are more common than credits,” says Madeline Hume, a senior analyst at Morningstar, a financial-services firm in Chicago. “About 50% of the population live in states where they are eligible for the state deduction.”
A new concept has been implemented recently in eight states—Arkansas, Colorado, Idaho, Illinois, Nebraska, Nevada, Utah and Wisconsin—to stimulate more participation in 529 plans. It encourages employers to contribute to an employee’s account and thereby receive a tax credit or deduction.
“For many years, CSPN members have advocated the development of a federal tax incentive to encourage employers to help their employees save for postsecondary education,” says CSPN’s Rachel Biar, who is also assistant state treasurer of Nebraska. “To date, members of Congress have expressed interest in this idea; however, no federal employer tax incentive has been created.”
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Source Article: http://www.wsj.com/articles/gift-tax-benefits-of-529-plans-11638391861
