529 Plan: Tax Strategy
When most people think of 529 plans, they think of a long-term savings strategy for college. However, there are a few states that allow individuals to take a state income tax deduction for contributions to a 529 plan, including Pennsylvania. This presents an opportunity for an additional 529 plan strategy that focuses more on short-term tax savings rather than a long-term investment strategy.
529 Plan Fundamentals
Before we get into details of how to use this strategy, let’s talk about a few basics of 529 plans and the deduction itself. There is not a federal tax deduction for contributions into a 529 plan, although the earnings grow tax-free in the account until they are distributed. If distributions from the 529 plan are for eligible college expenses, there is no income tax to pay on the distribution. Also, the Tax Cuts and Jobs Act law passed by Congress at the end of 2017 allows distributions of up to $10,000, for K-12 educational expenses. So, those who are paying for private K-12 education, the strategy discussed below could work well.
For the state of Pennsylvania, you may deduct up to $15,000 (single filer) or $30,000 (married filing jointly) of contributions to a 529 plan per beneficiary. This assumes that you have at least $15,000 of income for each tax filer.
Short-Term Tax Strategy
So how do you utilize this strategy effectively? For example, let us say your child received their college semester tuition invoice for $15,000. Instead of writing the check to the college, open a 529 plan, and deposit $15,000 into the 529 plan’s money market option. After the deposit is credited to your account, distribute the money from the 529 plan to the school to pay the tuition.
Now you just made a $15,000 contribution to your 529 plan and earned a $15,000 Pennsylvania state income tax deduction. In this example, a Pennsylvania resident could save themselves up to $460 in taxes.
It is important to mention that you should check with your 529 plan provider to ensure that they do not have any limits on how long the money must sit in their money market account before it can be distributed.
This strategy becomes powerful in a scenario where a family may be putting a few children through private K-12 education. In Pennsylvania, the average tuition for elementary and high school is approximately $11,444 per year, according to privateschoolreview.com. As I stated above, only $10,000 can be distributed from a 529 plan for K-12. So, to utilize this strategy you could contribute the first $10,000 of K-12 expenses into the 529 plan and then distribute it to the school. If a family of three is paying the average tuition listed above, they may not be able to run all K-12 expenses through the 529 plan, however, they would still be able to claim a $30,000 PA state tax deduction or $921 in tax savings.
