Should You Switch 529 Plans if You Move to Another State?

Families moving to a different state might consider changing their college saving strategy to maximize state income tax benefits. Depending on the state, the account owner may need to contribute to the in-state 529 plan in order to enjoy any tax deductions or credits offered. However, there is certainly no requirement to change 529 plans when moving states, so you’ll want to consider the potential benefits as well as any tax consequences for contributions or rollovers you make.

State income tax deductions or credits for 529 plan contributions

Your strategy may depend on the state you are moving to. If you are moving to one of the many states offering a state income tax deduction or credit for contributions only to an in-state 529 plan, opening a new 529 plan in that state may make sense.

If you are happy with your existing plan, you could keep that plan and open a second 529 plan in your new state to take advantage of the tax benefit. If the state has low limits on the annual state income tax benefit, you may want to split your contributions between the two states’ 529 plans. Contribute enough to the new home state’s 529 plan to maximize the state income tax benefit and contribute the rest to your existing 529 plan.

Many states have a limit on the amount of annual contributions that can be claimed on your state income tax. For example, in New York, only contributions of up to $5,000 per individual ($10,000 for married couples filing jointly) are eligible for the state income tax deduction. The same strategy would apply to states that offered matching grants up to a certain amount.

Nine states – Arizona, Arkansas, Kansas, Maine, Minnesota, Missouri, Montana, Ohio, and Pennsylvania – offer tax incentives for contributing to any state’s 529 plan. If you are moving to one of these states, you may be eligible to claim a state income tax benefit for contributions to your existing 529 plan.

State income tax deductions or credits for inbound 529 plan rollovers

In 18 states, you may be eligible to claim a state income tax benefit for rollover contributions from your existing 529 plan to your new 529 plan.

These states include:

• Alabama
• Arkansas
• Illinois
• Iowa
• Maryland
• Mississippi
• Montana
• Nebraska
• New Mexico
• New York
• Ohio
• Oklahoma
• Oregon
• South Carolina
• Utah
• Virginia
• Vermont 
• Wisconsin

Four states listed above – Illinois, New Mexico, Vermont, and Wisconsin – limit the tax deduction to the principal portion of the rollover. Arkansas has a lower limit on the tax deduction for rollovers than for new contributions.

Penalties for outbound rollovers

Families relocating may be tempted to roll their existing 529 plan funds into a 529 plan sponsored by their new state, even if there isn’t a tax benefit for inbound rollovers. Having just one 529 college savings plan per beneficiary is easier to manage. Other factors, such as state 529 plan contribution limits or varied investment options, may also influence your decision.

The IRS allows one tax-free rollover for 529 plans in a 12-month period. The easiest way to rollover funds is to open a new 529 plan account and complete a rollover distribution form on the existing 529 plan account’s website. You may also take a distribution from your existing 529 plan account and make a rollover contribution to the new account. 

Rollover 529 plan funds must be moved to the new 529 plan within 60 days, or the distribution will be considered non-qualified. The earnings portion of a non-qualified 529 plan distribution is subject to federal income tax and a 10% tax penalty, plus recapture of state tax benefits.

Your state may not follow the federal tax treatment for rollovers. Some states will “recapture” any state income tax deductions or credits previously claimed when 529 plan funds are rolled into another state’s 529 plan. Some states allow a state income tax deduction for inbound rollover contributions from another state’s 529 plan.