Contributions to a 529 plan are made with after-tax dollars, and therefore are not tax deductible at the federal level. However, some families using a 529 plan to pay for K-12 tuition may qualify for a state income tax deduction or tax credit for 529 plan contributions.
529 plans were originally designed to help families save for college costs; however, recent changes to the federal tax law expanded the definition of qualified higher education expenses to include up to $10,000 in elementary, middle or high school tuition per year. But, not all states have conformed to the federal law, so it’s important to understand your state’s rules and the potential impact of claiming a state income tax benefit for K-12.
529 plan state income tax benefits for K-12
If a state conforms to the federal tax law, 529 plan distributions used to pay for K-12 tuition (up to $10,000 per year) are exempt from state taxes. Conforming states may also offer a state income tax deduction or credit for 529 plan contributions when distributions are used to pay for K-12 tuition. Parents who qualify may funnel K-12 tuition payments through a 529 plan and claim an income tax benefit each year. With this strategy, you get the equivalent of an annual discount on private school tuition at your marginal state income tax rate.
What happens in non-conforming states
In non-conforming states, parents who use a 529 plan to pay for K-12 tuition are eligible for federal tax-free distributions, but the distribution may be taxed at the state level. The state may also recapture any state income tax benefits claimed. Taxpayers in California are also subject to a 2.5% penalty on 529 plan distributions used to pay for K-12 tuition. In effect, the state considers distributions for K-12 tuition to be non-qualified, even though they are qualified distributions at the federal level.
Who qualifies for 529 plan state tax benefits for K-12?
Almost all states allow grandparents or anyone else who contributes to a child’s 529 plan to claim a state income tax benefit for 529 plan contributions. Before giving a gift of college savings, check your state’s rules to see if your 529 plan gift will be deductible on state income tax returns. In most states, income tax deductions and credits are only available to residents who contribute to an in-state 529 plan.
Most states have a December 31 deadline for qualifying 529 plan contributions, but a few states give taxpayers until April to make retroactive contributions that qualify for state tax benefits. In 10 states, the contributor must be the account owner to claim the state income tax deduction or tax credit.
Be careful when using a 529 plan to pay for K-12 tuition
Parents who use 529 plan funds to pay for K-12 tuition risk jeopardizing future college savings. For example, if a family has been using a 529 to save for college expenses, and then they begin to use it for K-12 expenses as well, it can become very easy to "steal" from the student's college savings and not have as much as planned when college comes. This means the family will have to contribute significantly more per month to catch up for the same college savings goal.
Families should also carefully consider 529 plan investment options when using the funds to pay for K-12 tuition. Many 529 plans offer age-based asset allocation strategies that are designed for college savings, not K-12.
Using a 529 plan to pay for K-12 expenses can be a great way to take advantage of tax deductions in certain states, but you have to be careful to manage the investments in your account properly, and make sure you are organized so you don't jeopardize your student's college savings. If you would like help developing a strategy to use 529 plans to pay for your student's K-12 expenses, speak with an advisor by scheduling a free call with our team today!
Mike Bink, AAMS®, CCFS®
Mike works with families to simplify the college funding process and is widely recognized as an expert in college planning. He is passionate about empowering families to become informed consumers of higher education so that they don't pay a penny more for college than they absolutely have to.