We are contributing towards a 529 plan – are those tax-free in Germany?

Everybody knows that college in the US can be expensive. A 529 plan is a tax-advantaged savings plan to save for future education costs that come in two different ways – as education savings plans and prepaid tuition plans.

The education savings plans lets you open an investment account to save for the beneficiary’s future higher education expenses. Under those once can typically choose among a variety of investments – very often including ETF or mutual funds investments and a principal-protected bank product.

Prepaid tuition plans on the other hand let the account holder purchase units or credits for the beneficiary to use in the future at participating colleges and universities. You are essentially pre-paying future tuition and mandatory fees at the current prices.

Investing in a 529 plan is typically not a bad choice under US tax law as it may offer special tax benefits as follows:

  • Contributions: Many states offer tax benefits which may include deducting contributions from state income tax or matching grants.
  • If you use them for qualified higher education expenses earnings in the 529 account are not subject to federal income tax and, in many cases, state income tax.
  • Investment period: 529 plans provide for tax-free earnings that grow over a period of time. The longer your money is invested, the more time it has to grow.
  • Roll over: You can rollover funds in a 529 account into a Roth IRA account, which could be helpful if you have money left over after your student finishes college.

Now, the big question is which implications do the above have under German tax law? First of all, it is important to understand the Germany does not have anything that even remotely resembles a 529 plan. For this reason, you would need to treat a 529 plan as something the German tax law is familiar with and can handle. Most likely the 529 protection will hence just be disregarded, and the underlying investments be treated as a normal investment account. This has the following consequences for German taxes.

  • There is no 1099 or similar, as a 529 plan is not designed to show dividends, interest or capital gains.
  • For this reason, any “income” under the 529 plan needs to be calculated based on the investment information available, which can vary depending on the plan provider. We as taxperts usually go with a hands-on approach and work with lumpsum yields based on your investments as we see no need to make this more complicated than what it needs to be.
  • The contributions towards a 529 plan are not tax deductible under Germn tax law.
  • Withdrawals from a 529 plan may lead to taxable capital gains.
  • During the investment period the earnings will need to be treated as such – interest, dividends, capital gains… under German law there is no tax-free earnings growth!
  • The roll over however can still happen without any tax strings attached and it would actually be a neat thing to do as you could use it as a fairly tax-savy investment tool for future retirement – please see our comments on this subject with this article.

Please let us know if you have any questions on your 529 plans and how to best handle them on the German side.

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