How Much is your State’s 529 Tax Deduction Really Worth?

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Matthew Toner

By Matthew Toner

July 27, 2023

Many states offer state income tax deductions or credits for contributions to a 529 plan. The amount of your 529 state tax deduction will depend on where you live and how much you contribute to a 529 plan during a given tax year.

529 Plan Tax Benefits 

529 plans allow account owners, friends, and family to contribute to a college fund with after-tax income and enjoy two types of potential tax benefits: 

  • Federal tax benefits: 529 plan contributions grow federally tax-free and earnings are not subject to federal income tax when withdrawn for qualified education expenses, including up to $10,000 in K-12 tuition expenses and student loan payments. Note that there is no federal income tax deduction on 529 plan contributions. 
  • State tax benefits: Most states that have an income tax allow either a deduction from income or a state tax credit for 529 plan contributions when reporting income for state tax purposes. However, not all states follow the federal tax treatment of K-12 tuition or student loan expenses.

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, nine tax parity states 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.

Four states currently have a state income tax but do not offer a deduction for contributions: California, Hawaii, Kentucky, and North Carolina

Potential annual tax savings by state 

Us Tax Nl Saving for College
Estimated tax savings for a couple filing jointly with $100,000 in taxable income contributing $100/month to each of their two children’s 529 plans. Calculations assume taxpayers itemize deductions on their federal return.

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 total 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 Colorado, New Mexico, South Carolina, 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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