With college costs increasing at rates between 5-10%/year, it’s critically important for parents to think about putting aside dollars now to fund some portion of their children’s education. Luckily, there are very tax-efficient, low-cost savings vehicles available in the form of Section 529 College Savings Plans.
529 College Savings Plans – named after the section in the tax code where they are described – are similar to Individual Retirement Accounts, in that they provide a tax-deferred savings vehicle for account owners (“Participants”). Participants deposit funds into the account and invest them in mutual fund-like investments, which can include stock funds, bond funds and, in some cases, FDIC-insured cash accounts.
No taxes are due on growth within the plan until funds are actually withdrawn. But even withdrawals can be tax-free, as long as they are for qualified higher education expenses, like tuition, fees and, in some cases, room and board. Because the plans are intended to be exclusively for college or graduate school expenses, nonqualified withdrawals of any gains are taxed as ordinary income and assessed an additional 10% penalty.
Every state sponsors one or more 529 Savings Plans, but residents are not restricted to use the plan(s) offered by their home state. North Carolina’s 529 Plan is above average in terms of plan expenses and investment options. But there’s another component of the plan that makes it a fantastic option for state residents, namely that contributions are eligible for a state income tax deduction.
Individuals who contribute to the plan can deduct up to $2500/year of contributions from their state income taxes. For married couples, the deduction is up to $5000 of contributions. (You can contribute more, but the tax deduction is capped at the $2500/$5000 amount.) For a married couple in the 7% state marginal income tax bracket, that’s a savings of up to $350.
When the North Carolina plan was first available, the state tax deduction was subject to an income ceiling, meaning that if you made too much money you were ineligible for the deduction. To encourage more participation in the plan, the General Assembly removed that ceiling a few years ago but only temporarily. In fact, the ceiling was supposed to return next year!
Recently signed legislation, however, will preserve the state income tax deduction on NC 529 Plan contributions for all state residents, regardless of how much money they make. (The maximum annual contributions deductible from NC taxable incomes won’t change from their $2500 or $5000 levels.)
You don’t have to be an Account Participant to receive the tax deduction; you can take the deduction for contributions to someone else’s plan, as long as you are a North Carolina resident contributing to a North Carolina 529 Plan. You won’t get the deduction for a contribution to another state’s plan.
If you are interested in starting a college savings plan for a child, grandchild, niece, nephew, or anyone else, we’re happy to talk to you about the particulars. You can also find more information at the North Carolina College Foundation website, at http://www.cfnc.org/save/save.jsp/