CO 529: Tax Benefits, Contribution Limits, and Withdrawal Rules

Saving for education can be expensive, but a Colorado 529 plan offers tax advantages and flexibility to help families. These state-sponsored investment accounts grow tax-free when used for qualified expenses, making them a popular choice for college savings.

Understanding the rules around contributions, withdrawals, and tax benefits is key to maximizing these plans.

Eligibility Requirements

Opening a Colorado 529 plan is straightforward. Any U.S. citizen or legal resident over 18 with a valid Social Security or taxpayer identification number can open an account. This allows parents, grandparents, and even family friends to contribute toward a beneficiary’s education. There are no income limits, so anyone can participate.

The beneficiary—the person using the funds—must also have a Social Security or taxpayer identification number. There are no age restrictions, making the plan useful for children, teenagers, or adults returning to school. A single beneficiary can have multiple 529 accounts opened by different individuals, allowing for broader family contributions.

Contribution Limits and Caps

Colorado’s 529 plan allows for substantial contributions. While there are no state-imposed annual limits, federal gift tax rules apply. In 2024, individuals can contribute up to $18,000 per beneficiary per year ($36,000 for married couples filing jointly) without triggering the federal gift tax. A special five-year election permits lump-sum contributions of up to $90,000 ($180,000 for couples) without gift tax consequences, provided no additional gifts are made to the beneficiary during that period.

The state imposes an aggregate cap on total account balances. As of 2024, once a beneficiary’s total balance across all Colorado 529 accounts reaches $500,000, no further contributions can be made. This cap includes investment earnings, meaning accounts can grow beyond this threshold through returns, but new contributions are not allowed. Excess contributions are returned to the contributor.

Tax Considerations

Colorado taxpayers benefit from a state income tax deduction on 529 contributions. In 2024, residents can deduct the full amount of their contributions from state taxable income, provided the funds remain in the account or are used for qualified expenses. Unlike some states that impose annual deduction limits, Colorado does not cap this benefit. However, 529 contributions are not deductible at the federal level.

Investment earnings grow tax-free if withdrawals are used for qualified expenses. This offers a significant advantage over taxable brokerage accounts, where capital gains and dividends are subject to federal and state taxes. For example, if an investment doubles in value within a 529 plan, no capital gains tax applies upon withdrawal for education, unlike standard investment accounts, which may face a 15% or 20% federal capital gains tax, plus state taxes.

Withdrawals for non-qualified expenses incur taxes and penalties. Earnings on such withdrawals are subject to federal income tax and a 10% penalty. Additionally, Colorado requires taxpayers to add back any previously deducted contributions to their state taxable income if funds are used for non-qualified expenses. Exceptions exist, such as when the beneficiary receives a scholarship, attends a U.S. military academy, or becomes disabled. In these cases, the 10% penalty is waived, though income tax on earnings still applies.

Qualified Expense Guidelines

Funds must be used for eligible education-related costs to maintain tax advantages. Qualified expenses include tuition, fees, books, supplies, and equipment required for enrollment at an accredited institution. This applies to public and private colleges, universities, vocational schools, and certain apprenticeship programs registered with the U.S. Department of Labor.

Room and board are also covered for students enrolled at least half-time. The allowable amount is limited to either the actual cost of housing billed by the school or the institution’s published “cost of attendance” for off-campus housing, whichever is lower. Students should verify housing limits with their school’s financial aid office.

Technology expenses, including computers, software, and internet services, qualify if they are primarily used for education. Special needs services and equipment required for a beneficiary to attend school are also eligible.

Withdrawals and Penalties

Withdrawals for qualified education expenses remain tax-free. However, non-qualified withdrawals trigger a 10% penalty on earnings and are subject to federal and state income taxes. Colorado residents who previously deducted contributions must add back the withdrawn amount to their state taxable income.

Penalty-free withdrawals are allowed in specific cases. If the beneficiary receives a scholarship, attends a U.S. military academy, or becomes disabled, the 10% penalty is waived, though income tax on earnings still applies. If an educational institution issues a refund—such as for withdrawal from a program—account holders have 60 days to redeposit the funds into the 529 plan to maintain tax advantages. Proper documentation is essential to avoid unnecessary tax burdens.

Changing Ownership or Beneficiaries

Colorado 529 plans allow ownership and beneficiary changes. The account owner retains control over the funds and can transfer ownership to another individual, such as a spouse or relative, without tax consequences. This can be useful for estate planning.

Beneficiary changes are permitted as long as the new beneficiary is a family member of the original one, as defined by IRS guidelines. This includes siblings, parents, children, first cousins, and in-laws. If a child decides not to pursue higher education, parents can transfer the funds to another eligible relative without penalties. However, if the new beneficiary is in a different generation—such as a grandparent transferring funds to a grandchild—gift tax implications may arise depending on the amount transferred.

Rollover Options

Funds can be transferred between 529 plans once per 12-month period for the same beneficiary without tax consequences. This allows families to switch to plans with better investment options or lower fees. However, Colorado’s state tax deduction applies only to contributions made to its own plan, so rolling funds into an out-of-state plan could result in the loss of state tax benefits.

Beginning in 2024, up to $35,000 from a 529 plan can be rolled into a Roth IRA for the beneficiary, provided the account has been open for at least 15 years. This allows unused education savings to transition into retirement funds without penalties. However, the rollover is subject to annual Roth IRA contribution limits, meaning it may take multiple years to complete the full transfer.