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.
A 529 plan in Massachusetts gives its potential students an opportunity to save up money for college. The amount you put into the plan to use towards your education is not taxed by either the state or the federal government.
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 you're single and $2,000 if you’re married and filing jointly. There is no federal tax deduction for 529s.
529 Plan Owners and Beneficiaries
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.
State and Federal Withdrawal Penalties
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.
529 Plan Penalty Exceptions
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 2019
The IRS doesn't set specific annual contribution limits to 529 plans for 2019. But because these contributions are considered gifts, the $15,000 per-person annual exclusion and $11.4 million lifetime exclusion mean that most taxpayers will never reach these limits. As a result, your contributions are tax-free. The allowance up to $10,000 for K-12 education still stands as it did for 2018.
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.
Your 529 Plan in 2018
The original stipulation that your 529 funds can only be used for post secondary education changed beginning with the 2018 tax year. As of this year, the IRS allows you to spend up to $10,000 of your 529 funds annually to pay for kindergarten, 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.
- IRS.gov: About Publication 970, Tax Benefits for Education
- IRS.gov: 529 Plans: Questions and Answers
- MEFA.org: About Us
- Savingforcollege.com: The truth about college scholarships and 529 plans
- Savingforcollege.com: When your child wants to attend a U.S. Military Academy
- The Capital Group Companies: What 2018 tax reform means for investors
- SavingForCollege.com: How Much Can You Contribute to a 529 Plan in 2019?