529 State Tax Benefit

Guest Post by Kathryn Flynn, Content Director, Savingforcollege.com 

For most families, college is one of the biggest expenses they will ever face. If prices continue to rise at the current pace, it will cost over $300,000 to attend a four-year private university in 18 years. One of the best ways to prepare is to start saving as early as possible in a 529 college savings plan. 529 plans are designed to help save for college by offering federal tax-free compounding, and in some cases, additional state tax breaks. 

Similar to a Roth IRA, you deposit after-tax money into a 529 plan. Earnings in the account grow tax-free and will not be taxed when you withdraw the funds to pay for college. Qualified expenses include tuition, fees, books, some room and board, and even computers and related technology at any eligible institution. If the student decides not to go to college, you can choose to keep the account open and change the beneficiary to a qualifying family member, or take a non-qualified withdrawal. If you take a non-qualified withdrawal, you will have to pay income tax on any gains in the account. You will also be charged a 10% penalty on the earnings, except in certain cases, such as when the student gets a scholarship or attends a U.S. Military Academy. Keep in mind that, unlike Roth IRA withdrawals, 529 distributions are pro-rated, which means every withdrawal will include an earnings portion.

Just about every state sponsors at least one 529 plan, each with a unique selection of investment options to choose from, with varying objectives and costs. When researching plans, it’s a good idea to start by checking out

what your home state has to offer, since you may be eligible for additional tax benefits or other perks. Higher education is an important part of future prosperity and economic mobility, and many states actively encourage their residents to save for college. But, just like no two 529 plans are exactly alike, each state has its own rules when it comes to college savings benefits. It’s important to understand whether or not you qualify for a state tax break, and how much it could potentially be worth.

Here are some examples of what may be available in your state:

Tax deduction for contributions to any 529 plan

You can use almost any 529 plan to save for college, but in most cases, you need to use your home state’s plan to qualify for a state tax benefit. However, if you’re a taxpayer in Arizona, Kansas, Minnesota, Missouri, Montana or Pennsylvania, you can take a deduction for contributions to any 529 college savings plan, regardless of the state sponsor.

Tax deductions versus credits

Over thirty states currently offer residents a tax deduction for 529 plan contributions. That means each year, the amount you deposit will be deducted from your taxable income. States may specify a maximum deduction amount, ranging from $500 per beneficiary ($1,000 for married couples filing jointly) in Rhode Island to $14,000 ($28,000 if married) in Pennsylvania, but in Colorado, New Mexico, South Carolina, and West Virginia, there is no limit—529 plan contributions are fully deductible in computing state income tax.

If you live in Indiana, Utah, or Vermont, you may qualify for a state tax credit instead of a deduction. For example, Indiana residents can claim a 20% tax credit on up to $5,000 in 529 plan contributions, for a maximum credit of $1,000 per year.

In 2017, Minnesota became the first state to offer the option of claiming a tax deduction or credit for contributions to any state’s 529 plan. Residents may take a tax deduction for contributions of up to $1,500 ($3,000 for married couples filing jointly) or claim a credit on half of contributions up to $500, depending upon their income.

Other incentives

A number of states offer matching grants to help put college within reach for families. While Maine no longer offers a tax deduction for 529 plan contributions, residents may be eligible for an initial grant when they open a 529 account, a matching grant of up to $300 per year and an additional $100 grant when they set up automatic contributions. And during National College Savings Month each September and 529 Day (May 29th–get it?), many states organize workshops, contests, and other promotional events to educate families about the advantages of using 529 plans to save for college.

It’s also important to understand your state’s 529 plan rules. In Washington DC, for example, contributions of up to $8,000 per year by married couples are deductible, but this does not include deposits from an incoming 529 plan rollover. But in Illinois, where married couples can deduct up to $20,000 for contributions, the entire principal portion of a rollover is eligible. In New York, only the account owner (or their spouse if filing jointly) is able to deduct contributions, but in Wisconsin you can deduct contributions to a Wisconsin 529 plan even if you’re not the account owner.

No matter how attractive a tax deduction or other benefit may seem, it should not be your only consideration when selecting a 529 plan. As with any investment product, you’ll want to evaluate the risks and objectives to make sure they align with your saving strategy and goals. In some cases, you may find that lower fees and better investment performance from an out-of-state plan can outweigh the benefits of a tax deduction over time.

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Written by College Coach
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