Connecticut Tax Deductions for 529 Savings
By Tommy Martin, Financial Advisor
To encourage families to save for college, Connecticut offers tax deductions or credits to its residents. For example, Connecticut residents can deduct $5,000 to $10,000 per year per beneficiary for investments made to their CHET 529 account.
Connecticut families should consider investing in the CHET 529 plan if they are invested elsewhere for college. The tax deductions or credits offered by the state of Connecticut for contributions made to their CHET 529 plan can be considerable and help save money on taxes.
For a quick check of how much each state’s residents can deduct on their taxes, there are plenty of 529 map guides online. The map above from Invesco lets you know at a glance if there is any state tax benefit. Check it out. https://www.invesco.com/college-bound-529-plan/529-tax-benefits
Note, tax parity states allow you to deduct a certain amount on your state taxes whether you invest in that state’s plan or another state’s plan. Unfortunately, Connecticut requires its residents to invest in its state-sponsored CHET 529 plan for the tax deduction.
Transferring 529 money from one plan to another
Suppose you are a Connecticut resident and already opened a 529 plan elsewhere. In that case, you might want to consider the advantages of contributing to the CHET 529 Education Savings Plan. If it makes sense, you can “roll over” your money from one 529 plan to another – similar to a 401(k) rollover. There are some rules around this, so make sure you consult with your financial or tax advisor. We’re here to answer your questions as well.
It’s important to note that the IRS allows one tax-free rollover from 529 accounts per beneficiary in a 12-month period. Violations of this rule will treat the transaction as a non-qualified distribution, and you may be required to pay federal income tax and a 10% penalty on the earnings. If your beneficiary has multiple 529 accounts, you might not be able to roll them over during the same year.
How much can be invested in a 529 each year?
The general rule is that you can only contribute to how much college should cost your family, which is understandably vague. The cost of college varies from school to school, ranging from thousands of dollars to hundreds of thousands of dollars.
In addition, some custodians might have their only limitations. For example, Fidelity Investments, which manages Connecticut’s CHET 529 program, maintains a $300,000 lifetime limit on each beneficiary.
To avoid annual gift tax consequences, the maximum yearly amount invested must be less than $15,000 for a single taxpayer or $30,000 for a married filing jointly couple. These figures remained the same for 2021.
Carryforward deductions (and contributions)
A carryforward is a provision in the tax law that allows a taxpayer to apply some unused deductions, credits, or losses to a future tax year. Having a carryforward available is an excellent benefit because it enables investors to contribute more up-front without worrying about holding off on future contributions. The account owner can increase their potential return on one-time contributions through deductions and greater compounding returns.
Let’s look at a couple of examples:
Let’s say a single parent invested $7,500 into their child’s CHET 529 account this year. They can claim a $5,000 deduction this year and claim the remaining $2,500 deduction next year.
Let’s say an account owner contributes $40,000 into their child’s CHET 529 account this year. They can claim the $5,000 deduction this year and the next five years, but they will not be able to claim $10,000 since you can only carry the deduction for five years.
This is commonly referred to as “front loading.”
Furthermore, families that have considerable resources can leverage tax laws to “superfund” a 529 account. Superfunding a CHET 529 account allows the account owner to make five years’ worth of contributions in one shot while still qualifying for the annual gift tax exclusion!
For example, the 2021 gift tax exclusion is $15,000 per individual. With that in mind, an individual can make a lump-sum contribution of $75,000 ($150,000 for married filing jointly filers). That’s the annual gift tax exclusion of $15,000 x 5 years. If you do that, make sure it’s reported correctly on your tax return to avoid it being counted towards your lifetime estate and gift tax exemption.
Managing cash flow while in college
Many parents stop making contributions now that their students have arrived at college. This is a mistake and a loss of opportunity. As long as it makes sense, you should still consider contributing to your student’s CHET 529 account.
If you’re up in the air between contributing to your CHET 529 plan or using your cash flow to pay for college, keep in mind that you only get the tax deduction for contributions made to your CHET 529 account.
While the Connecticut tax deduction is a nice benefit for contributing to your CHET 529 account, the strongest reason to invest in a 529 is the tax-deferred growth and tax-free withdrawals for qualified expenses. There are many factors to consider when it comes to saving and paying for college.
We specialize in working with college-bound families to craft a well-thought-out and integrated college, retirement, tax, and investment plan. It’s all about creating an ideal college outcome.
Neither Independent Financial Group (IFG) nor any of its affiliates offer lending or repayment advice. The views expressed are those of the presenting party and may not express those of IFG or its affiliates. The information presented is for educational purposes only and is derived from sources assumed to be reliable. It is not to be relied upon as tax, legal, or financial advice, nor used for the purpose of avoiding any tax obligations. Please contact a qualified professional regarding your individual circumstances.
For Educational Purposes Only – Not to be relied upon as financial, tax, or legal advice. The views expressed are those of the author/presenter and all data is derived from sources believed to be reliable.