529 Plan For NRIs Returning Back To India - Is It Still Worth It?

As an NRI returning to India with investments in a 529 savings plan, it is important to understand the Indian tax law implications. Parents living in the United States invest in 529 savings plans for their children's education, which is a smart move if you are in the USA.

Upon returning to India, the taxation scenario will change entirely. The 529 savings plan, which is known for its tax-free growth and withdrawals in the US, becomes taxable under Indian tax laws.

Hence, it is important to understand how the Indian tax system will affect your 529 accounts.

In this blog, we will talk about 529 Plan Indian tax implications, what will happen when your child studies outside India, and whether a more flexible option exists.

What is Plan 529, and Why Do NRIs Use It?

The 529 Plan is a tax-saving investment option governed by the US Internal Revenue Code. This plan allows the money invested in it to grow on a tax-deferred basis. It can be withdrawn tax-free only for qualified expenses, such as college fees, K-12 tuition, apprenticeship programs, student loan payments, credentialing programs, and so on.

Although anyone can open a 529 account, it is often opened by grandparents or parents to save for their grandchild's or child's future educational costs, especially for U.S.-born children of Non-resident Indians (NRIs).

Other reasons for NRIs to choose a 529 plan include:

• There is no federal tax imposed on investment gains if used for qualified education.
• The plan is also exempt from estate taxes if it is appropriately structured (via 5-year superfunding).
• Control of the 529 accounts remains with the account holder, even as the child grows up.

But upon moving back to India, this is where the challenge for NRIs begins. On moving back to India and becoming a tax resident, the core advantage of a 529 plan account — its tax-free growth — diminishes, and the Indian tax authorities treat the account differently.

Why Most Asian Universities Do Not Qualify For 529 Plan Withdrawals

529 plans allow funding for higher education, but the list of eligible universities that accept 529 funds is limited. As per the IRS, the list of eligible institutions in Asia includes only a few universities in Singapore.

Universities in India do not qualify for 529 plan funding. Other eligible international universities and colleges are mainly in Australia and Europe.

If your child decides to study in India or elsewhere in Asia (excluding the selected institutions in Singapore), your withdrawals will not qualify as qualified withdrawals under IRS rules. Non-qualified withdrawals are subject to US income tax on earnings and an additional 10% penalty, which removes the US tax benefits the 529 plan offers.

How Does the 529 Plan Income Get Taxed When NRIs Become Tax Residents in India?

Upon returning to India and attaining Resident and Ordinarily Resident (ROR) status, the Indian Government taxes your global income, including income earned in the 529 plan.

While US tax laws allow 529 growth to be tax-deferred, Indian tax laws do not. Any growth in the account — including interest, dividends, and capital gains — will be subject to tax under Indian law.

This creates two key challenges for NRIs after attaining ROR status:

• Since your global income will be taxed as ROR, the tax deferral on 529 plan growth will not apply, and there is no exemption or postponement of tax on 529 plan growth.
• As per Section 89A of the Income Tax Act, deferrals in foreign retirement accounts are allowed, but Plan 529 does not qualify under this provision.

A Smart Alternative For Education Savings – Traditional IRA for US Education

If you are not sure your child will return to the US or another IRS-recognized university for higher education, a Traditional IRA may offer more flexibility.

Why a Traditional IRA is a good alternative:

• Any earnings in a Traditional IRA for higher education are exempt from the 10% penalty on early distributions, even if you are under 59½.

• Contributions are subject to income limits, and growth benefits are not as high as 529 plans, but it provides:

  • More flexibility in usage

  • Penalty-free access for education expenses in the US

  • Tax-deferred growth (taxed as ordinary income upon withdrawal)

A Quick Comparison – 529 Plan Vs Traditional IRA for NRIs Returning to India

The Bottom Line

As an NRI, having a 529 plan is a good move, but before investing, ask yourself:

1. Are you 100% sure your child will study in the United States or at an IRS-recognized institution?
2. Are you comfortable paying taxes in India annually on the income from your 529 accounts after returning to India?
3. Are you mainly using the plan for US estate tax planning?

If the answer to any of these questions is NO, consider alternatives such as a Traditional IRA or other flexible US investment options that offer lower tax implications upon returning to India.

As a returning NRI, if you need personalized expert-backed advice on US investments after returning to India, connect with Savetaxs. For a decade and more, we have been helping NRIs manage their:

• Cross-border investments, NRI taxation planning.
• US 529 plans, IRA, and brokerage account taxation compliance in India.
• Annual tax filing in India under the ROR statutes, and our experts will also consult you on double taxation or relief.

Connect with us for one-to-one consultations with top CAs and CPAs experienced in NRI taxation.