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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 taxable estate. 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 for qualified education expenses are income-tax-free. (Note that contributions to some states' plans can be state tax-deductible for residents of those states.)
While contributions to these accounts aren't tax-deductible, earnings grow free from state and federal taxes.
As with other 529 plans, for 2021, the California 529 plan allows individuals to contribute up to $15,000 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 — as much as $150,000 for married couples electing to split gifts or $75,000 for individuals — in one year. But, if you do so, 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.
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 plan accounts, you now can make up to $10,000 in withdrawals per year, per beneficiary, and free of federal tax when used to pay for tuition at the beneficiary's 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 qualified higher education expenses.) Either type of withdrawal can be used for expenses within or outside California.
You can open a California 529 plan account with as little as $25 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, though, you can't make any further contributions — though the account balance can continue to increase after that through investment growth.
As with other 529 plans, the earnings portion of withdrawals that pay for the beneficiary's qualified expenses such as tuition, fees, books and supplies are not taxed. If you use funds from a California 529 for nonqualified 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.
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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 your client invests in a Section 529 plan, they should be provided the plan's official statement and read it carefully. The official statement contains more complete information, including investment objectives, charges, expenses and risks of investing in the 529 plan, which they should consider carefully before investing. They also should consider whether their home state or their beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds and protection from creditors that are only available for investments in such state's 529 plan. Section 529 plans are not guaranteed by any state or federal agency.
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