Using Your State Income Tax Refund to Save for More College

Finding room in your budget for college savings can be challenging. Some families may prefer to make lump sum 529 plan contributions throughout the year instead of, or in addition to, automated monthly contributions. A lump sum lump may come unexpectedly, such as from an inheritance or lottery winnings, or you may have a recurring annual windfall such as a federal or state income tax refund.

How a state income tax refund can help grow a 529 plan

If you’re expecting a state income tax refund this year, consider depositing all or a portion of the refund for your child’s 529 plan. Your 529 plan contribution will grow-tax deferred and the funds can be withdrawn tax-free to pay for qualified education expenses. Contributing a tax refund each year to a 529 plan will help you reach your college savings goal and reduce the amount your child will have to borrow in student loans.

For example, a family who saves $250 each month in a 529 plan will accumulate around $95,000 by the time their child enters college, assuming a 6% annual investment return. If the same family were to save an additional $500 per year that they received from a state income tax refund, they could accumulate an additional $15,000 in savings.

Reinvest state income tax benefits for an additional 529 plan boost

Over 30 states offer a state income tax credit or state income tax deduction for 529 plan contributions. Families can redirect their state income tax benefit into a 529 plan by directly depositing their state income tax refund.

Taxpayers are usually required to use an in-state 529 plan to be eligible for a state income tax benefit, except in Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana and Pennsylvania, where residents are eligible to claim a state tax benefit for investing in any 529 plan.

Most states limit the amount of annual contributions eligible for a state income tax benefit, but 529 plan contributions are fully deductible in Colorado, New Mexico, South Carolina and West Virginia. 

How to deposit your state income tax refund into a 529 plan

Every state offers the option to directly deposit your state income tax refund into a checking or savings account. Families may deposit a state income tax refund into a bank account and then transfer the funds to a 529 plan.

17 states simplify the process by allowing taxpayers to contribute their state income tax refund directly into a 529 plan. Some of these states require the taxpayer to enter their 529 plan’s routing number on the state income tax return form, and some only require the 529 plan account owner’s account number or social security number.

The following table lists state that allow state income tax refunds to be directly deposited into a 529 plan, and the requirements for doing so.

Instructions for contributing a state income tax refund directly to a 529 plan

Source: Savingforcollege.com research