Susan E. Thomas CPA
Newsletter
How is money in a 529 plan treated for tax purposes?

Contributions: There is no federal income tax deduction for contributions to a 529 plan. However, states may offer a state income tax deduction (but they may limit the deduction to contributions made to the in-state 529 plan only). Check with your individual 529 plan or your state's taxing authority to determine the tax treatment in your state.

Withdrawals: If the money is used to pay the beneficiary's qualified education expenses, then the earnings portion of the withdrawal is free from federal income tax. States typically follow this federal tax treatment.

If the money is used for any purpose besides the beneficiary's qualified education expenses (called a non-qualified withdrawal), then the earnings portion of the withdrawal will be subject to federal income tax and a 10% penalty; state income taxes and a penalty may also apply. There are a couple of exceptions. The penalty is generally waived if you terminate the account due to the beneficiary's death or disability, or if you withdraw funds up to the amount of any scholarship the beneficiary has received.

In the case of a non-qualified withdrawal, the person who actually receives the money is the one who is subject to income tax. In most situations, this will be the account owner. However, some plans may allow the account owner to determine the recipient of a non-qualified withdrawal. Check the rules of your 529 plan for more information.

Note: Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. More information about 529 plans is available in each issuer's official statement, which should be read carefully before investing. Also, before investing, consider whether your state offers a 529 plan that provides residents with favorable state tax benefits.



Prepared by Broadridge Investor Communication Solutions, Inc, Copyright 2011