Does a 529 Plan Lower Your Taxable Income?
While 529 plans offer tax advantages for education, their effect on your taxable income often depends on state law and how the funds are ultimately used.
A 529 plan is a savings account designed to help families set aside funds for future education costs. These plans are named after Section 529 of the Internal Revenue Code. The plan offers a tax-advantaged way to save, as the money can grow without being subject to annual taxes, and withdrawals for qualified expenses are tax-free. This allows savings to accumulate more quickly than in a standard taxable account.
Federal Tax Treatment of 529 Plans
Contributions to a 529 plan are not deductible on your federal income tax return. This means that if you contribute $5,000 to a 529 plan, you cannot subtract that amount from your income when filing your federal taxes. The money you contribute is made on a post-tax basis, similar to how contributions are made to a Roth IRA.
The primary federal tax benefit of a 529 plan is the tax-deferred growth of the assets. As your contributions are invested, any earnings from interest or capital gains are not subject to federal income tax annually. This allows the earnings to be reinvested, which can accelerate the account’s growth. This tax deferral distinguishes a 529 plan from a typical brokerage account, where you would owe taxes each year on realized gains.
For gifting purposes, contributions to a 529 plan are considered completed gifts. In 2025, an individual can contribute up to $19,000 per beneficiary without incurring federal gift tax. A rule known as “superfunding” allows a contributor to make a lump-sum contribution of up to $95,000 ($190,000 for a married couple) in a single year and treat it as if it were made over five years for gift tax purposes.
State Tax Benefits for Contributions
While there is no federal deduction for 529 plan contributions, the opportunity to lower your current taxable income comes at the state level. More than 30 states offer an income tax deduction or a tax credit for contributions. This benefit directly reduces your state taxable income for the year you contribute, and the specific amount you can deduct varies by state.
The rules governing these state tax benefits differ. Most states that offer a tax break require you to contribute to their own specific 529 plan to be eligible. For example, a resident of a state with this rule would not receive a tax deduction for contributing to a neighboring state’s plan.
A smaller number of states have “tax parity,” which means they allow residents to claim a state tax deduction for contributions to any state’s 529 plan. This provides residents of these states with greater flexibility, as they can shop for the plan with the best investment options or lowest fees without losing their state tax benefit.
Some states allow a deduction for the full amount of the contribution, while others cap the deductible amount, such as at $5,000 for an individual or $10,000 for a married couple. A few states offer a tax credit instead of a deduction, which reduces your state tax bill dollar-for-dollar and can be more advantageous for many taxpayers.
Tax Implications of Withdrawals
The tax treatment of withdrawals from a 529 plan depends on how the money is used. When funds are withdrawn for “qualified higher education expenses” (QHEE), the entire withdrawal, including contributions and earnings, is free from federal income tax. This is a primary advantage of using a 529 plan.
Qualified expenses are broadly defined by the IRS and include costs required for enrollment at an eligible educational institution. These expenses cover:
- Tuition and fees
- Books, supplies, and equipment
- Room and board, if the student is enrolled at least half-time (the expense cannot exceed the allowance determined by the school)
- Computers, peripheral equipment, software, and internet access if used primarily by the beneficiary
Recent legislative changes have expanded the definition of qualified expenses. Up to $10,000 per year can be withdrawn federally tax-free to pay for tuition at an elementary or secondary school. Additionally, a lifetime limit of $10,000 per beneficiary can be used to repay qualified student loans.
The SECURE 2.0 Act of 2022 introduced another change, allowing for tax- and penalty-free rollovers from a 529 account to a Roth IRA for the beneficiary. This is subject to certain conditions, including a lifetime rollover limit of $35,000, and the 529 account must have been open for at least 15 years.
If you take a non-qualified withdrawal, the tax consequences are less favorable. The portion of the withdrawal representing your original contributions is returned tax-free. However, the earnings portion is subject to ordinary income tax at the recipient’s rate, plus an additional 10% federal tax penalty. For example, if you withdraw $10,000 for a non-qualified purpose and $2,000 is earnings, you would owe income tax on the $2,000, plus a $200 penalty.