Different states, different 529 plan rules

By: Savingforcollege.com


Dear Joe, What states allow you to make tax-deductible contributions to a 529 plan? -- Pam


Dear Pam,
I don't mean to question your question, but it seems to me the only state you should be asking about is the one in which you reside. Other states' laws are irrelevant.

If you live in California, for example, and you make contributions to Pennsylvania's 529 plan, the fact that Pennsylvania permits a tax deduction for contributions to a 529 plan does not affect your California state income tax liability. Only Pennsylvania taxpayers stand to benefit. Your use of another state's 529 plan does not cause you to file tax returns in that state.

For the record, however, 34 states and the District of Columbia offer an upfront tax break for contributions to a 529 plan. It's much easier to list the seven states that do NOT offer a deduction (excluding the states that do not impose an income tax): California, Delaware, Hawaii, Kentucky, Maine, New Jersey, and North Carolina.

If you live in a state offering a tax break, here are some of the additional questions you should be asking:

Does my state offer a tax deduction or a tax credit?

Only four states -- Indiana, Minnesota, Vermont and Utah -- offer a tax credit in place of a deduction. Indiana's is especially generous, giving you 20 cents off your Indiana tax liability for every dollar you contribute to the Indiana 529 plan. The maximum Indiana credit is $1,000 per individual tax return. Minnesota offers a credit or a deduction, dependent on which taxing system you elect to use in that state.

Does my state allow the deduction for contributions to out-of-state 529 plans?

Most states allow a deduction only for contributions to the in-state 529 plan. In six states -- Arizona, Kansas, Minnesota, Missouri, Montana, Pennsylvania -- taxpayers can claim a deduction for contributions to any state's 529 plan.

Is there a cap on the deduction or credit?

Most states impose a limit on the amount of deduction you can claim each year. For example, Michigan's deduction cap is $5,000 per tax return, increased to $10,000 for Michigan taxpayers filing a joint return. In Iowa, the cap is set at $3,239 per beneficiary in 2017 (the cap is increased each year for inflation), so the more beneficiaries you have the more you can deduct. Four states have no annual limit, offering the potential for a six-figure deduction. Those states are Colorado, New Mexico, South Carolina and West Virginia. The state of Virginia has no limit for taxpayers age 70 and over, but limits the deduction to $4,000 per account for those below the age of 70.

If I contribute more than the cap, can I carry forward the excess to next year's state tax return?
In New York and most other states, contributions in excess of the deduction cap cannot be carried forward, in which case you may want to consider spreading your contribution over two or more years to obtain a bigger state tax benefit. The following governments permit excess contributions to be carried forward for a limited number of years: Arkansas, Connecticut, District of Columbia, Maryland, Oklahoma and Oregon. Ohio, Louisiana, Rhode Island, Virginia and Wisconsin place no limit on the number of carryover years.

Are there any other restrictions on my ability to deduct the contributions made to my 529 account?

You'll need to understand these restrictions to avoid unpleasant surprises. Several states disallow the deduction for contributions made by individuals who are not the account owner. Some states allow rollovers from other states' 529 plans to be deducted, while others do not. In Maine deductions are disallowed for taxpayers with incomes above certain limits. In Wisconsin, the maximum deduction is reduced in some cases for parents who are married but filing separately or who are divorced.

What is the deadline for making the contribution?

Most states have established Dec. 31 as their deadline, but check to see if the deadline in your state refers to the postmark date or to the date of delivery. A small number of states use April 15 of the following year as their deadline.

Popular Questions


Two kids, two 529 plans?

Dear Big Bill,
While it's possible to maintain a 529 plan in just one child's name, even when you intend to send more than one child to college, I generally recommend that families open a separate 529 account for each child.

That's assuming there is no additional cost to maintaining multiple accounts. If your 529 plan charges an annual or quarterly account maintenance fee, check to see if you can avoid the fee by signing up for automatic contributions through payroll deduction or electronic funds transfer)

With a separate 529 plan for each child, it becomes easier for you to tailor the mix of stocks, bonds and stable-principal investments (e.g., stable value, guaranteed principal and money market funds) to the particular ages of your children. When your older child is nearing high school graduation, you may want to ratchet down the level of market risk in her 529 plan. At the same time, you could keep a more-aggressive asset allocation in your younger child's 529 plan, accepting more risk for a potentially higher return. Many 529 plans offer "age-based" investment options that automatically make these adjustments as the beneficiary ages.

Separate accounts for your children also offer more gift-tax leeway. Since your 529 contributions are treated as gifts from you to the account beneficiary, your $15,000 (in 2018) annual gift exclusion will go twice as far with two accounts -- one for each child -- than with just one account.

Financial aid is another reason to recommend maintaining separate accounts. You wouldn't want the investments reserved for your younger child's future college expenses to count against your older child's financial aid eligibility. Be warned: The rules here are rather murky, and the impact of a sibling's 529 account may depend on the college's own policies as well on as the type of aid -- federal or institutional -- being sought.

Finally, I believe that separate 529 accounts allow for better family bookkeeping. There will never be any doubt as to your intention to help send all of your children to college. You'll avoid the uncomfortable position of being asked to explain to a curious 8th-grader why account statements are showing up in the mail with only a brother or sister's name on them. And in the event of your death or divorce, no matter how unlikely, your legal representatives and other family members will have less reason to question your actions in setting up and funding the 529 plans.

Even with separate accounts, you'll continue to have the flexibility to shift the money around in the future. You simply need to make sure that whenever funds are withdrawn from the 529 plan to pay for college they are coming from an account in the name of the child incurring the costs. It's a simple matter to change the beneficiary designation among family members at any time, transfer 529 funds between different family members' accounts or split one 529 account into two. The ability to move assets around the family is a key advantage of 529 plans when comparing other college-savings alternatives, such as Uniform Transfers to Minors Act, or UTMA, accounts.

Original Post: 2005-10-13
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Coverdell ESA vs. 529 Plan: Which to choose? (Script)

The Coverdell ESA and the 529 plan are both excellent college savings vehicles because they are both tax-free when used for college. But many families face a choice: do they use a 529 plan for all of their child's college savings, or do they use a Coverdell for the maximum amount of $2,000 each year and put any any extra savings above $2,000 into a 529 plan? In spite of its low annual contribution cap, Coverdell's are now attracting quite a few families. There are two major reasons for that. One is that only the Coverdell allows you to self-direct your investments, just like you might self-direct the investments in your IRA. The other is that in addition to college expenses, Coverdells can be withdrawn tax-free to pay for a broad range of K-12 expenses, while 529 plans are limited to K-12 tuition. This feature is appreciated most in families planning to send their children to private grade schools, which may include additional costs such as room and board or uniforms. A 529 plan, on the other hand, does not impose age limits or income limits like the Coverdell does and so overall we see a lot more money going into 529 plans than into Coverdells. Plus many savers are happy with the investment choices offered by the 529 plans and don't necessarily want to self-direct their investments. And don’t forget this: your state may be giving you a state tax deduction for using a 529 plan, but there are no states offering a state tax deduction for investing with a Coverdell ESA.

Learn more about Coverdell ESAs.

Original post date 2013-07-15
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Top 529 Plan Withdrawal Tips. (Script)

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Top 529 Plan Withdrawal Tips. (Video)

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