The 529 Massachusetts Tax Break

A 529 plan is a state-sponsored education savings plan. The money you put in it and its earnings can be used to pay for educational expenses at most accredited U.S. colleges and universities. It can also be used for vocational schools, some foreign educational institutions as well as religious, primary and K-12 schools. To open a 529 account, you have to be a U.S. resident of any state and of legal age in your state. Both federal and Massachusetts state tax laws provide a number of benefits to using a 529 plan to save for college.

Massachusetts 529 Tax Benefits Abound

Massachusetts’ 529 college investing plans are managed by Fidelity in conjunction with the Massachusetts Educational Financing Authority. MEFA is a not-for-profit state organization that works to make higher education more affordable. They offer low interest student loans and they work with Fidelity on the 529 college investment plan.

These plans offer some serious tax breaks. For starters, the money you put in a 529 account and its earnings are not taxed by the feds or the state of Massachusetts. Neither is it taxed when you withdraw it as long as you use it for qualified educational expenses like tuition, room and board, books and equipment, like a laptop.

Additionally, if you’re a resident of Massachusetts you can claim a Massachusetts 529 plan tax deduction for the amount you deposit in the plan each year. This deduction is capped at $1,000 if your single and $2,000 if you’re married and filing jointly. There is no federal tax deduction for 529s.

Federal and State Exceptions

Although it’s usually parents and grandparents who open 529 accounts, any U.S. resident who is 18 years or older can open one. You must have a U.S. mailing and legal address, a Social Security number or Federal Tax ID number. When you open a 529 account you are the owner or participant. You control it. You decide when and how much to invest, and you’re in charge of distributing the money. The beneficiary of the account can be anyone, including yourself, as long as they have a Social Security or Federal Tax ID number. You can change the beneficiary at any time.

The owner of a 529 plan can withdraw money from it at any time for any reason. However, if the withdrawn funds are not used to pay for educational expenses, the earnings portion will be subject to both state and federal income tax, and an additional 10 percent federal penalty tax will be applied.

There are some exceptions to the 10 percent penalty. If the beneficiary gets a scholarship, you can withdraw money up to the amount of the scholarship and use it for other things without incurring the penalty. Another exception is if your beneficiary decides to attend military school. Military schools waive tuition, room and board, books and other expenses in exchange for signing up for five years of active duty. The Military Family Tax Relief Act of 2003 treats the cost of attending a U.S. military school as a scholarship. So, like scholarships, you can withdraw funds from the 529 account up to the value of the military school’s education without being hit with the penalty tax.

The 10 percent penalty tax is also waived if your beneficiary is unable to use the money for education because they’ve become incapacitated or died. With all of these exceptions you still have to pay taxes on the earnings portion of what you’ve withdrawn.

Your 529 Plan in 2018

There was no change in annual contribution limits to 529 plans for 2018. They remain $15,000 for single taxpayers and $30,000 if you're married and filing jointly. However, the original stipulation that your 529 funds can only be used for post secondary education did change.

Beginning with the 2018 tax year, the IRS allows you to spend up to $10,000 of your 529 funds annually to pay for elementary and high school education at a public, private or religious school. This can be a big help to parents who want to enroll their children in private schools.

Your 529 Plan in 2017

The 2017 tax year was the first time Massachusetts allowed a deduction for contributions made to 529 plans. This deduction, which remains in effect through the 2021 tax year, was capped at $1,000 for a single person or head of household, and $2,000 for a married couple filing jointly.

If you use the money you withdrew for anything other than educational expenses, Massachusetts will take the deduction back for the tax year. Exceptions to this deduction recapture are, if the beneficiary dies, becomes disabled or receives a scholarship.

These deductions may be limited if the difference between what you withdrew, minus any scholarships, grants or financial aid, is more than 25 percent of your adjusted gross income as defined by Massachusetts state tax authorities. Check with your professional tax adviser to find out if this could apply to you before you withdraw the money.

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