Will I Get a State Tax Break If I Use an Out-of-State 529 Plan?

For most families, a 529 plan is the most effective way to save for college. Contributions are made with post-tax dollars, earnings grow tax-deferred and distributions are completely tax-free when used to pay for qualified higher education expenses. You may also be eligible for state income tax benefits, depending on where you live and which 529 plan you contribute to.

Do I have to use my home state’s 529 plan?

529 plans are state-sponsored, but that doesn’t always mean you have to use your in-state 529 plan to save for college. Any 529 plan can be used to pay for college in any state. You can use almost any state’s 529 plan, with the exception of six 529 plans that have state residency requirements:

• Connecticut Higher Education Trust (CHET) Advisor Plan – The account owner must have a Connecticut mailing address or be a Connecticut resident on active duty in the U.S. Armed Forces.

• Louisiana START Saving Program – The account owner or the beneficiary must be a resident of Louisiana at the time of enrollment.

• New Jersey NJBEST College Savings Plan – The contributor or the beneficiary must be a resident of New Jersey at the time of enrollment.

• South Carolina Future Scholar 529 College Savings Plan (Direct-Sold) – The account owner or the beneficiary must be a resident of South Carolina or an employee of the State of South Carolina at the time of enrollment.

• South Dakota CollegeAcess 529 (Direct-Sold) – The account owner or the beneficiary must be a resident of South Dakota at the time of enrollment.

• West Virginia SMART529 WV Direct College Savings – The account owner or the beneficiary must have a West Virginia mailing address or be a West Virginia resident on active duty in the U.S. Armed Forces.

State income tax deductions and credits

Over 30 states offer a state income tax deduction or state income tax credit for 529 plan contributions. However, in most states you must contribute to an in-state 529 plan to be eligible for a tax break on your state income tax return. In these states, taxpayers who deduct contributions to an out-of-state’s 529 plan will be subject to taxes and possible civil penalties.

For example, Illinois offers a state income tax deduction for contributions up to $20,000 for married couples filing jointly, but only if the contributions are made to an Illinois-sponsored 529 plan. If an Illinois resident contributes to New York’s 529 College Savings Program the contributions are not deductible from Illinois taxable income.

However, there are seven tax parity states allow residents to claim a state income tax deduction or credit for contributions to any 529 plan: Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana and Pennsylvania.

State tax-deferred growth and state tax-free withdrawals

Similar to federal 529 plan tax benefits, most states offer state tax-deferred growth and state-tax-free distributions when the money is used to pay for qualified education expenses. Alabama is the only exception. For taxpayers in Alabama, distributions from an out-of-state 529 plan are not exempt from Alabama state income tax. The earnings portion of the distribution (whether it is qualified or non-qualified) will be reported as income on the taxpayer’s Alabama state tax return.

States where you can get a tax break for using any 529 plan

When you may want to consider an out-of-state 529 plan

Sometimes it makes sense to use an out-of-state 529 plan, even if it means you’ll miss out on a state tax break. For families with young children, low fees are a more important criterion than a state income tax benefit when selecting a 529 plan. A state income tax deduction or credit generally provides greater value once the child enters high school.