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529 Tax Savings When College is Already Here
by Joe Hurley, founder, Savingforcollege.com
Saturday, January 14th 2006

There's one 529 planning tip that rarely fails to impress people in my home state of New York (and it should be of equal interest in approximately two dozen other states). I usually mention it only after someone says to me: “It’s too late for me to use 529 plans. My kid’s already in college.”

Here is the idea: Rather than pay the upcoming tuition bill directly from your other savings, first put the money into your state’s 529 plan so that you can claim a state income tax deduction. Then use the 529 money to pay the college bills. Voila!—part of the cost of college becomes a write-off on your state income tax return. You might save hundreds of dollars in state income taxes—could be more, could be less—simply by putting the money through the 529 plan.

Of course, this only works if you live in one of the states offering a tax deduction for 529 contributions (26 states and the District of Columbia do*), and it works best in states that do not require that the funds be held in the 529 plan for any minimum period of time (very few states require this).

Because of revenue loss and tax policy considerations, I doubt your state tax department appreciates this planning idea. The 529 program administrators don’t like it either, because the transaction costs involved in setting up a new 529 account and immediately making payments are typically much greater than the revenue associated with the account. I wouldn’t be surprised to see more states adding a holding period requirement in the future, although to do so would add greater complexity to an already-complex topic. (Michigan addresses this issue by requiring its taxpayers to reduce otherwise-deductible contributions by qualified withdrawals taken during the year.)

The rules governing state tax treatment of 529 plans are notoriously fickle. So before acting on this idea, please consult with your own tax professional.

*The following states allow their taxpayers to claim some or all of their contributions to the in-state 529 plan as a deduction or credit in computing state income taxes: Arkansas, Colorado, District of Columbia, Georgia, Idaho, Illinois, Iowa, Kansas, Louisiana, Maryland, Michigan, Mississippi, Missouri, Montana, Nebraska, New Mexico, New York, Ohio, Oklahoma, Oregon, Rhode Island, South Carolina, Utah, Vermont, Virginia, West Virginia, and Wisconsin.

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