Are Contributions to a 529 Plan Tax Deductible?

Covering school tuition costs is often best approached using a methodical plan of tucking back savings a little at a time. You can maximize the amount of your savings by choosing a 529 plan that shelters your contributions from federal income taxes, which means 100 percent of your plan savings can be applied to qualified education costs. While you can't deduct your contributions on your federal taxes, state tax benefits for contributions do exist.

How 529 Plans Work

Named for the IRS code number that defines it, a 529 plan is also called a qualified tuition program. As a state-operated savings account, the benefits of a 529 plan include no income eligibility requirements and no residency requirements.

For example, you can contribute to a 529 plan in a different state from where you live. This makes the 529 plan grandparent-friendly for out-of-state grandparents who want to help their grandchildren with education costs.

Understanding 529 Tax Benefits

All states and the District of Columbia offer 529 plans. But because each state has its own 529 plan, there is a lot of latitude in the details. Typically, you’ll choose between a prepaid tuition plan and a savings plan, both of which follow different guidelines in different states.

You’ll still get the federal tax benefit of exempting your contributions to a 529 plan from income taxes, regardless of which state plan you choose. But while many states offer tax-deductible benefits, others do not. You’ll have to shop around to find the plan that works best for you.

Exceptions to Section 529 Tax Deductions

Each 529 plan defines qualified educational expenses for which you can make tax-free withdrawals from your account. Commonly approved costs include tuition, books and room and board at eligible schools. You can also make non-qualified withdrawals, but you’ll have to pay taxes when you withdraw these funds, and you’ll also pay a 10 percent federal tax penalty.

There are three exceptions to this penalty rule:

1. If the student beneficiary of a 529 plan receives a scholarship, you can withdraw any amount up to the full scholarship award from the 529 plan that equals the amount of the scholarship.
   
2. You can also make a withdrawal from a 529 plan in any amount up to the cost of attendance for a military academy student.
   
3. If the intended beneficiary dies or has a permanent disability, you can withdraw funds from the 529 plan; you can transfer the plan funds to another student who is a member of the original beneficiary’s family or you can transfer the plan funds to the beneficiary’s estate.

Tax Law Changes

Since 1996 when Congress created 529 plans, qualifying schools typically have included colleges, universities, vocational schools and other postsecondary learning institutions. But beginning with the 2018 tax year, the federal Tax Cut and Jobs Act of 2017 has made tax qualifying schools also include enrollment or attendance in eligible elementary or secondary private, public or religious schools.