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When strategizing on how to save for college, many families turn to 529 plans. These tax-efficient college savings accounts offer many advantages and great flexibility for those who want to invest money for their child’s college education.
However, there is some complexity in the 529 plan landscape. The total amount you can contribute varies by state (although the limits are high in all areas). Many states offer tax relief on contributions, but only up to a set maximum. Additionally, you will need to understand if your contributions are subject to federal gift tax.
Here’s what you need to know once you’ve decided to save for college using a 529 plan.
How 529 Plans Work
529 plans are investment accounts, often offered by individual states, that allow your money to grow tax-free as long as you use the money for eligible expenses. Contributions are paid after tax; when you withdraw income from a 529 plan to pay eligible educational expenses, that money is not subject to tax. Many states also offer tax credits or state deductions for 529 contributions.
To open a 529 college savings account, the account holder, such as a parent, will choose a plan and combination of investments, then make regular contributions that will eventually be withdrawn to pay for the beneficiary’s education costs (in this case, their child). You are free to choose any 529 plan across the country, even if you don’t live in the state that offers it.
You can save in a 529 plan, regardless of your income. Investing money rather than setting it aside in a traditional savings account means you’re more likely to experience growth over time due to market conditions. The plans offer age-based investment portfolios that can help you determine the right mix of investments based on the beneficiary’s expected college start date.
529 Plan contribution limits
An important feature of 529 plans, which sets them apart from other investment accounts like Roth IRAs, is that there is no annual contribution limit. You can save as much as you want on an annual basis, although each 529 plan has a lifetime total contribution limit. There are also other limitations that may affect your tax burden that you should be aware of. Let’s explore below.
Federal Gift Tax Limits
Contributions to a 529 plan are considered a donation, according to the IRS, which could trigger the need to file a donations return and possibly pay taxes on the amount you contributed. But if the amount donated falls below a certain threshold, you are exempt from gift tax and the need to file a gift tax return. In 2022, you can contribute up to $16,000 to a 529 plan ($32,000 as a married couple filing jointly) and benefit from the annual gift tax exclusion, which allows you to avoid the gift tax.
Plus, there’s an additional workaround: you can contribute up to five years of gift tax exclusion in one year, up to $80,000 total in 2022, or $160,000 for married taxpayers filing jointly. This amount will be considered to have been contributed over a period of five years, which means avoiding gift tax and gift tax return for up to $80,000 (or $160,000) of contributions in one year.
529 Global Limits
Although 529 plan providers don’t limit you to a certain amount you can save per year, they will institute an overall limit. This means that you can only contribute up to a certain maximum amount per beneficiary.
The aggregate limit is usually quite high – $500,000, for example – and can help you avoid overfunding a beneficiary’s account(s) beyond what your family can reasonably expect to pay in fees. studies. If you hit the limit, your money will stay invested and continue to have the potential to grow over time.
529 Limits on tax benefits
You can opt for a 529 plan offered by any state, but you may qualify for a tax deduction or credit if you choose certain state options. However, it’s worth checking how much you could save with this tax relief, as states often place limits on the amount of 529 plan contributions you can claim as a deduction or credit.
A common limit is $5,000 in tax-deductible contributions per year ($10,000 for a married couple filing jointly), but it can vary. In Massachusetts, for example, savers can only deduct $1,000 over 529 contributions ($2,000 for a married couple filing jointly), while in Colorado the 2022 limit is $20,000 ($30,000 for joint filers).
529 Aggregate Plan Contribution Limits by State
Each state’s 529 plan provider sets its own aggregate contribution limit. Find each state’s lifetime contribution limit per beneficiary below. For more details on each state’s plan, see our full list of 529 plans from each state.
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