Is a 529 Plan Tax Deductible in Texas?

A 529 plan is an investment account designed to help individuals save for future education expenses. These plans are sponsored by states or educational institutions, offering a tax-advantaged way to set aside funds for a designated beneficiary’s schooling. Their primary purpose is to provide a dedicated savings vehicle for costs associated with higher education and, more recently, K-12 tuition.

Federal Tax Benefits of 529 Plans

529 plans offer significant federal tax advantages. Contributions to a 529 plan grow on a tax-deferred basis. When funds are withdrawn, they are entirely tax-free at the federal level, provided they are used for qualified education expenses.

Qualified education expenses are broadly defined by the Internal Revenue Service (IRS) and include a range of costs associated with eligible educational institutions. These typically encompass tuition, fees, books, supplies, and equipment required for enrollment or attendance. Room and board expenses also qualify if the student is enrolled at least half-time. The scope of qualified expenses has expanded to include up to $10,000 per year for K-12 tuition at public, private, or religious schools, as well as costs for registered apprenticeship programs and limited student loan repayments.

Texas State Tax Implications for 529 Plans

Texas does not offer a state income tax deduction for 529 plan contributions. Texas is one of a few states that does not impose a state individual income tax. Because there is no state income tax, residents of Texas cannot claim a state income tax deduction for contributions made to a 529 plan.

This absence of a state income tax deduction applies universally, regardless of whether the contributions are made to a Texas-sponsored 529 plan or a plan offered by another state. While other states may offer tax credits or deductions for 529 contributions to incentivize their residents to save, Texas does not have such provisions. The primary tax benefits for Texans using a 529 plan stem from the federal tax advantages, such as tax-deferred growth and tax-free withdrawals for qualified expenses.

Tax Treatment of 529 Plan Distributions

Withdrawals from a 529 plan receive specific tax treatment depending on their use. However, if withdrawals are not used for qualified education expenses, they are considered non-qualified distributions. In such cases, the earnings portion of the withdrawal becomes subject to federal income tax. Additionally, a 10% federal penalty tax may apply to the earnings portion of non-qualified withdrawals. There are certain exceptions to this 10% penalty, including withdrawals made due to the beneficiary’s death or disability, or if the beneficiary receives a tax-free scholarship.