Contributions to a 529 plan are made with after-tax dollars, and therefore are not tax deductible at the federal level. However, some families using a 529 plan to pay for K-12 tuition may qualify for a state income tax deduction or tax credit for 529 plan contributions.

529 plans were originally designed to help families save for future higher education costs. Funds saved in a 529 plan account grow tax-deferred and can be withdrawn tax-free at the federal level when they are used to pay for qualified higher education expenses.

Recent changes to the federal tax law expanded the definition of qualified higher education expenses to include up to $10,000 in elementary, middle or high school tuition per year. But, not all states have conformed to the federal law, so it’s important to understand your state’s rules and the potential impact of claiming a state income tax benefit for K-12.

529 plan state income tax benefits for K-12

If a state conforms to the federal tax law, 529 plan distributions used to pay for K-12 tuition (up to $10,000 per year) are exempt from state taxes.

Conforming states may also offer a state income tax deduction or credit for 529 plan contributions when distributions are used to pay for K-12 tuition. Parents who qualify may funnel K-12 tuition payments through a 529 plan and claim an income tax benefit each year. With this strategy, you get the equivalent of an annual discount on private school tuition at your marginal state income tax rate.

What happens in non-conforming states

In non-conforming states, parents who use a 529 plan to pay for K-12 tuition are eligible for federal tax-free distributions, but the distribution may be taxed at the state level. The state may also recapture any state income tax benefits claimed. Taxpayers in California are also subject to a 2.5% penalty on 529 plan distributions used to pay for K-12 tuition. In effect, the state considers distributions for K-12 tuition to be non-qualified, even though they are qualified distributions at the federal level.

Who qualifies for 529 plan state tax benefits for K-12?

Almost all states allow grandparents or anyone else who contributes to a child’s 529 plan to claim a state income tax benefit for 529 plan contributions. Before giving a gift of college savings, check your state’s rules to see if your 529 plan gift will be deductible on state income tax returns.

In most states, income tax deductions and credits are only available to residents who contribute to an in-state 529 plan. But, taxpayers in Arkansas, Kansas, Missouri and Pennsylvania may claim a state income tax benefit for contributions to any state’s 529 plan that is used to pay for college or K-12 tuition.

Most states have a December 31 deadline for qualifying 529 plan contributions, but a few states give taxpayers until April to make retroactive contributions that qualify for state tax benefits.

In 10 states, the contributor must be the account owner to claim the state income tax deduction or tax credit.

Other potential impacts of using a 529 plan to pay for K-12 tuition

Parents who use 529 plan funds to pay for K-12 tuition risk jeopardizing future college savings. For example, if a family starts saving for a child’s education at birth and holds the funds in a 529 plan until they begin college, about a third of their ending 529 plan balance will be made up of investment earnings. But, if the family waits until the child enters high school to start saving for college less than 10% of their 529 plan balance will come from earnings. This means the family will have to contribute about six times more per month to reach the same college savings goal.

Families should also carefully consider 529 plan investment options when using the funds to pay for K-12 tuition. Many 529 plans offer age-based asset allocation strategies that are designed for college savings, not K-12. For example, if parents select an age-based asset allocation for a 5-year-old, the portfolio will shift allocations and become more conservative over a 13-year time horizon. Some states, including Louisiana and Kentucky, have introduced new investment options to better accommodate families saving for K-12 tuition.