There are many ways to save for college, but why not pick the way that will also save you money on your taxes? That’s a big reason most experts recommend a 529 plan.
529 plans are tax-advantaged accounts that help families save for college. Think of them like IRAs, but for education. Money invested in a 529 plan is tax-deductible to some extent in 34 states. Usually, contributions have to be made to your own state’s plan to be deductible. In Ohio, for example, residents can contribute to CollegeAdvantage, Ohio’s 529 plan. They can deduct up to $4,000 per year per beneficiary for 2018. This is an increase over the 2017 amount of $2,000 per beneficiary.
Save for College With A 529 College Savings Plan
Withdrawals from 529 plans—regardless of your state—are also tax-free when used for a qualified college expense, including tuition, room and board, books, computers, and supplies.
Wondering how this could play out for your family? Consider this scenario. Several years ago, the Smith family of Cleveland opened a 529 account for their fifth-grader. They picked CollegeAdvantage, Ohio’s plan. Every year since then, the Smiths have saved $2,000 in their 529 account. And every year, they’ve deducted that $2,000 from their Ohio income taxes. What’s more, when it comes time to start using the money, the Smiths’ withdrawals—including any gains in the account—will also be tax-free.
If the Smiths had saved the same amount each year in a regular savings account, they would not have received the $2,000 tax deduction (or the up to $4,000 per year per beneficiary deduction starting in 2018). Rather, they would have had to pay taxes on any interest earned.
With the average savings account in the United States paying less than 1 percent in interest a year, money in a regular savings account tends to grow slowly. By contrast, money in a 529 account can be invested in mutual funds, which have historically outpaced savings accounts when it comes to returns. That can add up to more money towards college tuition.
Are 529 Plans Tax Deductible For Grandparents, Too?
It’s not just parents who can take advantage of the tax benefits of 529s. Grandparents and other family members may also be eligible.
“Grandparents can also take the deduction for contributions to a CollegeAdvantage account, if they are Ohio residents,” explains Timothy Gorrell, executive director of the Ohio Tuition Trust Authority, which manages CollegeAdvantage. In Ohio, there are no familial restrictions on who can make and deduct contributions to Ohio’s 529 plan. “Once you have a 529 account established, then you, grandparents, even aunts and uncles can put money in and it will have no bearing on the tax write-off,” Gorrell says.
Meanwhile, wealthier families can use another provision of the tax code to fund a 529 account for a beneficiary.
“A key benefit of 529 plans is the five-year gift tax averaging,” explains Mark Kantrowitz, president of Skokie, publisher and VP of research at savingforcollege.com, and a leading expert on paying for college. “Normally, one can contribute up to $15,000 per year without incurring gift tax. As a couple, Grandma and Grandpa can give up to $30,000 per grandchild. But, 529 plans let them give up to five times this amount—$75,000 each or $150,000 as a couple—in a lump sum. You can have it treated as though it were given over the next five years.”
And if you contribute more than the allowed deduction in a given year? “You can roll the excess amount over to deduct the next tax year,” explains Gorrell.
Fund Your 529 with Your Tax Refund
Here’s an idea to get your 529 started—or give it a boost. If you’re getting a tax refund for 2017, consider investing it in a 529 plan. In Ohio, the average tax refund was $2,460 in 2016. According to research by the Ohio Tuition Trust Authority, families who invest $2,500 a year in a 529 account will be able to cover about 40 percent of the cost of an Ohio public university (based on 18 years at 6 percent growth).
“If you are able to do that annually, then you’ll have saved almost half the cost,” says Timothy Gorrell, executive director of the Ohio Tuition Trust Authority.