Does Tennessee Have a 529 Tax Deduction?
While Tennessee's state tax laws have changed, the TNStars 529 plan remains a key tool for education savings due to its powerful federal tax advantages.
A 529 plan is a specialized savings account designed to help families set aside funds for future education costs. These plans, named after Section 529 of the Internal Revenue Code, allow savings to grow without being subject to annual federal taxes. Tennessee’s specific program is the TNStars College Savings 529 Program, which is open to any U.S. resident. The primary appeal of these plans nationwide often involves a combination of federal and state tax advantages. State tax laws, however, can change, directly impacting the benefits available to residents.
The Current Status of the Tennessee 529 Tax Deduction
As of January 1, 2021, Tennessee no longer offers a state tax deduction for contributions made to the TNStars 529 plan. This change is a direct result of the complete repeal of the state’s Hall Income Tax, which was an income tax applied to certain investment earnings like interest and dividends. Prior to its repeal, this was the only form of broad-based individual income tax in the state.
The deduction for 529 plan contributions was specifically designed to reduce a taxpayer’s liability under the Hall Income Tax. With the full elimination of this tax, there is no longer any state-level income tax from which to deduct contributions. Consequently, the associated tax deduction became obsolete.
Current Tax Benefits of the TNStars 529 Plan
Despite the elimination of the state-level deduction, the TNStars 529 plan remains a powerful savings vehicle due to its significant federal tax advantages. The primary benefit is tax-deferred growth, meaning any investment earnings generated within the account are not subject to federal income tax on an annual basis. This allows the account’s value to compound more rapidly than it would in a standard taxable investment account.
The most impactful benefit is that withdrawals are entirely free from federal income tax, provided the funds are used for Qualified Higher Education Expenses (QHEE). These expenses are broadly defined by the IRS and include tuition and fees, room and board, books, supplies, and required equipment.
Federal law now permits the use of 529 funds for uses beyond college. Account owners can withdraw up to $10,000 per year, per beneficiary, to pay for tuition at an elementary or secondary public, private, or religious school. Additionally, a lifetime limit of $10,000 per beneficiary can be withdrawn tax-free to repay qualified student loans. These federal benefits are not dependent on state law and provide compelling reasons for families to continue utilizing the TNStars program for their education savings goals.