Change in Maryland 529 Plan Rules

As the end of the year nears we have many clients asking how they can help their children and grandchildren save for college. One of the best ways to do this is to use a qualified tuition plan, otherwise known as a 529 plan. These plans were authorized by Section 529 (hence the name!) of the Internal Revenue Code. Earnings from these accounts are not subject to federal tax (or state tax in most cases) as long as the distributions are used for eligible higher education expenses. As an additional benefit, many states offer a deduction on your state income tax return for making a contribution. There can be some drawbacks to 529 plans, as Rosemary explained a couple years ago, but the benefits generally are greater and we frequently recommend their use. 

 

All 50 states plus DC sponsor at least one type of 529 plan. There is no requirement that you use the 529 plan offered by your state, but most states do require you to use their sponsored plan to qualify for a tax deduction. That's the case here in Maryland, where many of our clients reside. For years Maryland has offered a deduction of up to $2,500 for each account holder who contributes funds for a beneficiary. Any amounts contributed in excess of those limits can be carried forward for 10 years and deducted on future returns.

 

Under the old rules, a married couple filing jointly with three kids is able to take a deduction for up to $15,000 of 529 plan contributions for the year, but in order to get that full amount they would EACH need to have an account set up for EACH of their kids. That means this couple would need to have 6 different accounts set up with the Maryland College Savings Plan. If they just had one account for each child they'd only be allowed to take a $7,500 deduction. Furthermore, if their parents also wanted to make contributions to the children (their grandchildren) they would need to set up their own accounts for each child in order to take a state tax deduction themselves.

Luckily earlier this year Maryland passed Senate Bill 374 to fix this confusion and simplify the process. Now, every person who contributes money to a qualified plan is able to claim the subtraction modification, regardless of who the account holder is. So the theoretical couple in the above example would be able to open up one account for each kid for a total of 3 accounts, then contribute $5,000 to each to claim the full deduction on their state tax return. 

It also means grandparents and other relatives will be able to contribute to those same accounts and take a deduction on their returns.  Let's say Aunt Jane wants to put $500 in each of her niece and nephews's 529 plans as a Christmas present. If they already have accounts set up in their names, she can now easily do this AND take a $500 deduction on her tax return for each of those contributions!

 

The bill took effect July 1, 2016 and applies to tax year 2016 and beyond. If you are considering making year end contributions to 529 plans you should evaluate how you are doing this and whether you are maximizing your potential tax benefit. It is important to keep good records on your contributions and where they go just in case Maryland ever questions the deduction on your return. 

 

If you'd like to discuss college funding and 529 plans in general or these specific new rules, feel reach to reach out to us anytime.