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How Much Is the 529 Tax Deduction Worth?

The 529 plan comes with an array of tax deductions which can yield huge savings when you pay for college. But how much are these deductions really worth? The answer can change based on many factors. How much you contribute, the number of years in which you contribute, and the state you’re in can all determine how much your deduction is worth. Let’s break down all of the relevant factors.

Related: All about the tuition and fees deduction

529 plans explained

A 529 plan is a type of savings plan that students, their family, and family friends can use to help save for college. The 529 plan has special educational tax advantages. Withdrawals are not subject to federal, and usually state, taxes. This means that your investment can grow over time without being taxed. If you are saving for college for yourself or for someone else, 529 plans are typically the best way to do it. Their benefits are magnified the earlier you start saving.

Also see: Education tax credits you can earn

How total contribution affects your 529 plan deduction

Tax deductions can potentially lower your taxable state income by excluding the amount of your contribution. So, at a state tax rate of 5%, a $1,000 deduction would save you $50. Keep in mind, this deduction is only available in some states, and is never available federally.

529 plan contributions are made from after-tax income. But depending on your state, you may be able to deduct these contributions from your state taxes. So, the more you contribute, the higher your deduction will be. 529 plan earnings are also exempt from federal taxes. So even if your income is taxed, the earnings in the account will not be.

Learn more: How does a 529 plan impact financial aid?

How annual limits affect your 529 plan deduction

State limits

Each state has its own maximum annual deduction for 529 plans. To maximize your state deduction, try to spread your 529 plan contributions out over many years. If you make a few large contributions instead of pacing them, some of them will not be deductible from your state taxes.

Federal limits

529 contributions made by a family member run the risk of being taxed by the government. However, 529 plan contributors can use the gift and estate tax exemption to circumvent this. The gift and estate tax exemption has an annual limit of $15,000. Therefore, it’s wise to space out your contributions to a 529 plan.

It’s also possible to make more than $15,000 of 529 plan contributions per year. You can choose to “superfund” your 529 plan by making one large contribution which counts against your limits for future years. You can also deduct contributions over $15,000 against your lifetime gifts and estate contribution limit. This limit is set at over $11 million, so very few people exceed it.

For more information: How much can I contribute to a 529 plan?

How your state of residence affects your 529 plan deduction

Each state has its own policy for taxable income deductions. Some states don’t have a 529 plan deduction, so you won’t be able to deduct any of your state income. Others will allow you to deduct up to $15,000 per year.

If you live in a state with a low 529 plan deduction, make sure to start contributing early so you can space out your contributions. This will maximize your deduction and save you the most money. It’s a good idea to try to deduct as much of your college fund as possible from state taxes.

Also read: What are the 529 plan rules?

Don’t forget interest

Remember, if you start investing in a 529 plan early, your savings will compound as time goes on. The money that you saved in tax deductions will compound every year and your savings will continue to grow. Your tax deductions will be worth more the sooner they land in the bank. And on top of that, they will not be subject to federal taxes. So start saving early to get the most out of your 529 plan!

Related: How to choose a 529 plan

Frequently asked questions about maximum 529 plan deductions

How much can a parent put in a 529 plan per year?

There is no limit to yearly contributions for a 529 plan – only that the total balance cannot exceed the projected cost of your child’s education. It’s also a good idea to spread out your contributions, as even the most generous states only allow you to deduct up to $15,000 of 529 plan deductions from your taxes.

Even if you exceed your yearly state deduction limit, it’s a good idea to put money in your 529 account, because all of the earnings will be tax-free.

How much can a grandparent put in a 529 plan per year?

For grandparents, 529 plan contributions and deductions work in a very similar way. You’ll want to keep your contributions under $15,000 a year if possible in order to take full advantage of any state deductions. Grandparents also have to utilize the Gift Tax in order to avoid taxation on the contribution. You can contribute up to $15,000 per year under this contribution.

That being said, grandparents can fund up to $75,000 in one year, using Gift Tax “superfunding.” Nevertheless, it’s a good idea to pace out your contributions to stay under $15,000 per year if you live in a state that allows 529 deductions.

Are 529 plan contributions pretax or post tax?

Your plan contributions will always be post tax. You’ll pay tax on your income, then contribute it to your plan. However, earnings on the balance will be tax-free. What’s more, some states will allow you to deduct your contributions at the end of the year, so you effectively will not pay state taxes on them.

Does contributing to a 529 plan reduce taxable income?

Contributing to a 529 plan reduces taxable income at the state level, in select states. However, it never reduces federal taxable income.

Final thoughts

This article provides general information. Always talk to your accountant or financial planner to determine the best type of college savings plan for your family and the tax benefits of those plans.