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Does a California 529 plan offer tax advantages?

Answered by
Richard Polimeni
Director, Education Savings Programs, Bank of America
Like 529 plans sponsored by other states, California's state-sponsored 529 plan can offer tax-advantaged growth as well as a way to potentially shrink your estate for federal tax purposes. While contributions to California's plan are not deductible at the state or federal level, all investment growth is free from state and federal taxes, and the earnings portion of withdrawals used for qualified education expenses are federal and California state income tax-free. (Note that contributions to some states' plans can be state tax-deductible for residents of those states.)
While contributions to 529 accounts aren't tax-deductible, earnings grow free from state and federal taxes.
As with other 529 plans, the California 529 plan allows individuals to contribute up to a certain amount per year per account without triggering any federal gift taxes or using any of your lifetime gift tax exclusion amount. You also may step up your giving by making five years' worth of contributions per beneficiary in one year. But, if you do, you won't be able to make additional annual tax-free gifts to the beneficiary for five years unless the gift-tax exclusion amount increases during that time or you use some of your lifetime gift tax exemption. To learn more, refer to the Annual Limits Guide (PDF).
California's 529 plan is available to any citizen or taxpayer in any state but if you are not a California resident, you should consider whether your home state offers state tax benefits for investing in that plan. You can make withdrawals free from federal — and possibly state and/or local — income taxes to pay for qualified higher education expenses for the beneficiary. As with all 529 plans, the earnings portion of withdrawals that pay for the beneficiary's qualified expenses like tuition, fees, books and supplies is not taxed. Additionally, you can make up to $10,000 in withdrawals per year, per beneficiary, and free from federal tax when used to pay for tuition at the beneficiary's eligible public, private or religious elementary or secondary schools. State tax treatment of withdrawals for primary or secondary education varies by state. (There is no $10,000 annual limit for other qualified higher education expenses.) Withdrawals can be used for eligible education expenses within or outside California.
If you use funds from a California 529 plan account for non-qualified purposes, the earnings portion of withdrawals will be taxed as ordinary income and may be subject to a 10% additional federal tax, as well as a 2.5% additional income tax in California.
You can open a California 529 plan account and name as beneficiary your child, your grandchild, yourself or even someone outside your family. Once the account balance in a California 529 plan account (or the total of all California accounts for one beneficiary) reaches $529,000, you can't make any further contributions — though the account balance can continue to increase thereafter through investment growth.
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Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
Before you invest in a Section 529 plan, request the plan's official statement from your Merrill Financial Solutions Advisor and read it carefully. The official statement contains more complete information, including investment objectives, charges, expenses and risks of investing in the plan, which you should carefully consider before investing. You should also consider whether your home state or your designated beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds and protection from creditors that are available only for investments in such state's 529 plan. Section 529 plans are not guaranteed by any state or federal agency.
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