How much is your state’s 529 plan tax deduction really worth?
In addition to federal tax benefits, many states offer state income tax deductions or credits for contributions to a 529 plan. The amount of your 529 plan state income tax benefit will depend on where you live and how much you contribute to a 529 plan during a given tax year.
States that offer an income tax benefit for 529 plan contributions
Over 30 states, including the District of Columbia currently offer a state income tax deduction or tax credit for 529 plan contributions. In most cases, the taxpayer must contribute to their home state’s 529 plan to qualify for a state income tax benefit. However, there are seven tax parity states that offer a state income tax benefit for contributions to any 529 plan:
In the majority of states, the full amount or a portion of a taxpayer’s 529 plan contribution is deductible in computing state income tax. But, Indiana, Utah and Vermont offer a state income tax credit for 529 plan contributions. Minnesota taxpayers are eligible for a state income tax deduction or credit, depending on their adjusted gross income.
Seven states currently have a state income tax, but do not offer a deduction for contributions: California, Delaware, Hawaii, Kentucky, Maine, New Jersey, and North Carolina.
Potential annual 529 plan tax savings by state
How 529 plan state income tax benefits work
State income tax benefits are based on the amount of a taxpayer’s total 529 plan contributions in a given tax year. While there are no annual contribution limits for 529 plans, most states limit the amount of contributions that qualify for an income tax credit or deduction. For example, New York residents are eligible for an annual state income tax deduction for 529 plan contributions up to $5,000 ($10,000 if married filing jointly). In New Mexico, South Carolina, Virginia and West Virginia 529 plan contributions are fully deductible in computing state income tax.
For most taxpayers, there is no requirement to hold funds in a 529 plan for a specified amount of time before claiming a state income tax benefit. Taxpayers can contribute to a 529 plan, immediately tax a qualified distribution to pay for college or K-12 tuition and qualify for the state income tax benefit. However, Montana and Wisconsin block this state tax deduction loophole by imposing time limits, and Michigan and Minnesota base state income tax benefit on annual contributions net of distributions.
Parents saving for K-12 tuition and adults using a 529 plan to pay for graduate school may get the equivalent of an annual discount on tuition by funneling payments through a 529 plan and claiming a state income tax benefit each year,
Most states require 529 plan contributions to be made by December 31 to qualify for a state income tax benefit, but taxpayers in six states have until April to make 529 plan contributions that qualify for a prior year income tax deduction.
Who is eligible for a 529 plan state income tax benefit?
States typically offer state income tax benefits to any taxpayer who contributes to a 529 plan, including grandparents or other loved ones who give the gift of college. However, in 10 states only the 529 plan account owner (or the account owner’s spouse) may claim a state income tax benefit.
Eligible taxpayers may continue to claim a 529 plan state income tax benefit each year they contribute to a 529 plan, regardless of the beneficiary’s age. There are no time limits imposed on 529 plan accounts, so families may continue to make contributions throughout the child’s elementary school, middle school, high school, college years and beyond.
State income tax benefits should not be the only consideration when choosing a 529 plan. Attributes such as fees and performance must always be taken into account before you enroll in a 529 plan. In some cases, better investment performance of another state’s 529 plan (where earnings are compounded) can outweigh the benefits of a state income tax deduction.
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