The Tax Benefits of Iowa 529 College Savings Plans

College student studying at computer
•••

Hero Images / Getty Images

If you're planning to put a child or another loved one through college and you live in Iowa, you should know about the two types of 529 college savings plans available to you. Investments in these 529 accounts grow free of federal and state income taxes, and all withdrawals used for qualified higher education expenses are exempt from federal and state income tax.

In addition, every Iowa taxpayer who contributes to a 529 plan can deduct up to $3,387 per beneficiary from their income for state tax purposes. That figure applies to 2019 and is adjusted for inflation every year. If a married couple has two children, each spouse can deduct $3,387 for contributions made to each child's account, for a total of $13,548.

Through these tax-deductible plans, family members and even friends can contribute to a child's college fund and get a tax break for doing so. (Since January 1, 2018, 529 accounts can also be used for expenses at an elementary or high school.) College plan money must be used for qualified expenses such as tuition and fees, room and board, books, required supplies, computer hardware (including a printer) and software, internet access, any equipment required for enrollment or attendance, and certain expenses required for a special needs student. The maximum amount that can be saved for a single beneficiary is $400,000.

U.S. residents may participate in 529 plans for a state in which they do not live, but they could lose in-state tax benefits by doing so.

The Two Types of Iowa Plans

Iowa offers two types of 529 plans, both of which are designed to help save for higher education, including two- and four-year colleges, graduate programs, and technical and vocational schools. (Some states offer plans that enable participants to pay for tuition in advance, at the current rate, but Iowa does not.) The Iowa plans, like other such state plans, are named after the numbered section of the Internal Revenue Service code that authorized states to create them.

  • College Savings Iowa 529 Plan: This is a 529 savings program that's managed by Vanguard Group Inc. and overseen by the Treasurer of the State of Iowa. The plan offers four different age-based tracks that also take into consideration investors' desired risk level, along with 10 portfolios from which investors can choose up to five selections to make their own lineup of funds. All plan portfolios invest in Vanguard mutual funds but are not themselves considered to be mutual funds. The plan is sold directly to investors.
  • IAdvisor 529 Plan: This is a 529 savings program that's managed by Voya Investment Management and overseen by the Iowa State Treasurer’s Office. The options in the plan are not considered to be mutual funds, although they invest in mutual funds. An investment in any of the plan options is an investment in municipal securities, and the value of the options will vary according to the value of their underlying funds. Assets are managed by Baillie Gifford, BlackRock, Brandywine Global Investment Management, Brookfield, Credit Suisse, Delaware Investments, Hahn Capital Management, Lazard Asset Management, LSV Asset Management, Polaris Capital Management, VanEck, Voya Investment Management, and Wellington Management. The plan lets you invest according to the age of the benefactor, by risk level, or in a portfolio of funds you create. It is sold through financial advisors.

Both plans are subject to fees. Returns are not guaranteed, and investments made in the plans could lose money.

529 Plans Vs. Other Savings Accounts

Iowa residents trying to decide whether they should use an Iowa 529 plan or other savings vehicles need to account for the potential savings of a state income tax deduction. (Residents do not receive an Iowa income tax deduction for contributions made to any other state's 529 plan.) While the deduction is attractive, it may not offset the benefits of using other, nondeductible accounts, such as a Coverdell Education Savings Account or Uniform Transfers to Minors or Uniform Gifts to Minors custodial account. Talk to your financial advisor or a similar professional about which plan is likely to give you the greatest benefit.

Gift Tax Exemption

Iowa residents can contribute up to $75,000 in one year ($150,000 for a married couple filing jointly) per beneficiary without incurring a federal gift tax. However, the donor or donors can not make any additional gifts to that beneficiary for five years. Alternatively, a single resident can contribute up $15,000 a year every year—and a married couple can contribute up to $30,000—without incurring the gift tax.

Claiming the 529 Deduction

Taxpayers must complete Iowa State Form 1040 to claim the Iowa 529 tax deduction. The deduction is combined with other adjustments to income and listed on line 24 of the return. The tax return must include a brief explanation of the educational expenses.

Unqualified Withdrawals

Any plan withdrawals that are used for something other than qualified education expenses are subject to federal and state income taxes as well as a 10% federal tax penalty.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.