The 529 contributions are never federally tax-deductible. However, some states may consider 529 contributions tax-deductible. Check with your 529 plan or your state to find out if you're eligible. A 529 plan allows you to save for college or higher education and, at the same time, receive some type of tax benefit. The holder of a 529 account can withdraw funds at any time and for any reason, but keep in mind that the portion of the profits from unqualified withdrawals will incur income taxes and an additional 10% penalty.
Contributions to a 529 plan don't have to be reported on your federal tax return. You won't receive a 1099 form to report taxable or non-taxable earnings until the year you make the withdrawals. You can change the investment options in your 529 plan twice per calendar year, and you can transfer your funds to another 529 plan once in a 12-month period. Earnings from your 529 account and withdrawals from it are not subject to federal taxes when used for qualified educational expenses. This means that you won't pay federal income taxes as your account grows over the years, or federal income taxes when your beneficiary withdraws funds to use for qualified higher education expenses, such as tuition, room and board, books, and more. While your contributions to the 529 University Savings Plan are not tax-deductible, you still receive a benefit.
As an investment account, the 529 plan accumulates profits, allowing the 529 plan to grow tax-free. When it's time to withdraw these earnings to cover eligible educational expenses, you won't have to pay distribution taxes. Unfortunately, you can't apply for a federal income tax deduction for your contributions to a 529 plan. However, depending on where you live, you may qualify for a deduction on your state income tax return. Several states offer a state income tax deduction for contributions to a 529 plan.
Once again, keep in mind that most states allow you to apply for an income tax deduction on your state tax return only if you contribute to your own state's 529 plan. Amounts deducted for these purposes may be recaptured as state taxable income in subsequent years. In addition, if you plan to apply for a state income tax deduction for your contributions, you should know if your state applies income recovery rules to 529 plans. New Mexico is one of only four states in the country that offers an unlimited state tax deduction for contributions to its 529 plan. It's always a good idea to consult with a professional tax advisor to make sure you comply with all tax regulations and don't duplicate any benefits. You should consult your own state laws to determine the income tax treatment of contributions and withdrawals.
Ultimately, your tax professional is the best person to advise you on what deductions you can get depending on your circumstances. Then, if you withdraw funds to pay the beneficiary's qualifying education expenses, the portion of the retirement income is free of federal income tax. The essential thing to remember about tax deductions is to keep good records and keep all documentation related to qualified expenses. Your contributions accrue deferred taxes, which means you don't pay income taxes on earnings each year. These states don't offer tax deductions or credits for 529 contributions, nor do they have state income taxes. In general, you won't be required to pay income taxes to another state simply because you opened a 529 account in that state.
