With my son approaching another birthday, I’ve started thinking more seriously about his schooling from elementary to college/university. My parents paid for a significant part of my education and I would like to do the same for my son.
Given the rising cost of tertiary education, I figured the earlier I save the better. And thanks to the tax advantages, one of the best ways to save for a child’s college education is to put money regularly into a 529 plan. This plan is named after Section 529 of the federal tax code and also known as a Qualified Tuition Program or Plan (QTP).
According to the College Board the average annual cost of tuition, room, board, and fees was around $42,000 at a private four-year college and $18,000 at a public four-year college.
So early tax-advantaged saving coupled with the benefits of compounding make investing in a 529 plan a smart financial move. There are two main types of 529 plans, prepaid tuition plans and college savings plans, and each comes in many forms.
529 Plan State Tax Deduction Limits
Here are the current limits on state tax deductions for 529 contributions:
|State||529 State Tax Deduction|
|Alabama||$5,000 per parent ($10,000 joint)|
|Alaska||No state income tax|
|Arizona||$2,000 single or head of household/$4,000 joint (any state plan)|
|Arkansas||$5,000 per parent ($10,000 joint)|
|Colorado||Full amount of contribution|
|Connecticut||$5,000 per parent ($10,000 joint), 5 year carryforward on excess contributions|
|Florida||No state income tax|
|Georgia||$2,000 per beneficiary|
|Idaho||$4,000 single/$8,000 joint|
|Illinois||$10,000 single/$20,000 joint per beneficiary|
|Indiana||20% tax credit on contributions up to $5,000 ($1,000 maximum credit)|
|Iowa||$3,163 single/$6,326 joint per account|
|Kansas||$3,000 single/$6,000 joint per beneficiary (any state plan), above the line exclusion from income|
|Louisiana||$2,400 single/$4,800 joint per beneficiary, above the line exclusion from income, unlimited carryforward of unused deduction into subsequent years|
|Maine||$250 per beneficiary|
|Maryland||$2,500 per account per beneficiary, 10 year carryforward|
|Michigan||$5,000 single/$10,000 joint, above the line exclusion from income|
|Mississippi||$10,000 single/$20,000 joint, above the line exclusion from income|
|Missouri||$8,000 single/$16,000 joint, above the line exclusion from income|
|Montana||$3,000 single/$6,000 joint, above the line exclusion from income|
|Nebraska||$10,000 per tax return ($5,000 if filing separate), above the line exclusion from income|
|Nevada||No state income tax|
|New Mexico||Full amount of contribution, above the line exclusion from income|
|New York||$5,000 single/$10,000 joint, above the line exclusion from income|
|North Carolina||$2,500 single/$5,000 joint, above the line exclusion from income|
|North Dakota||$5,000 single/$10,000 joint|
|Ohio||$2,000 per beneficiary per contributor or married couple, above the line exclusion from income, unlimited carryforward of excess contributions|
|Oklahoma||$10,000 single/$20,000 joint per beneficiary, above the line exclusion from income, five-year carryforward of excess contributions|
|Oregon||$2,265 single/$4,530 joint (i.e., $2,265 per contributor) per year, above the line exclusion from income, four-year carryforward of excess contributions|
|Pennsylvania||$14,000 per contributor/$28,000 joint per beneficiary (any state plan)|
|Rhode Island||$500 single/$1,000 joint, above the line exclusion from income, unlimited carryforward of excess contributions|
|South Carolina||Full amount of contribution, above the line exclusion from income|
|South Dakota||No state income tax|
|Texas||No state income tax|
|Utah||5% tax credit on contributions of up to $1,900 single/$3,800 joint per beneficiary (credit of $95 single/$190 joint)|
|Vermont||10% tax credit on up to $2,500 in contributions per beneficiary (up to $250 tax credit per taxpayer per beneficiary)|
|Virginia||$4,000 per account per year (no limit age 70 and older), above the line exclusion from income, unlimited carryforward of excess contributions|
|Washington, DC||$4,000 single/$8,000 joint, above the line exclusion from income|
|Washington||No state income tax|
|West Virginia||Full amount of contribution up to extent of income, above the line exclusion from income, five-year carryforward of excess contributions|
|Wisconsin||$3,000 per dependent beneficiary, self or grandchild, above the line exclusion from income|
|Wyoming||No state income tax|
What is a 529 Plan?
A 529 prepaid tuition plan lets you buy tuition credits or units at today’s rate and use them later when your child attends a participating college or university. The value of your credits – often called “shares” – increases tax-free at the same rate as tuition, so a prepaid tuition plan lets you lock in at the current tuition rate.
For example, if you buy shares worth a year’s tuition at a participating college, your shares will always be worth a year’s tuition, even years later when the tuition might cost much more. Most prepaid tuition plans are sponsored by the states, and each state sets its own rules for them.
State prepaid tuition plans generally cover tuition only at public colleges and universities in that state, though some cover tuition at private universities in those states. Some states offer extra benefits to people who contribute to their 529 plan, such as matching grants or an option that lets you save for room and board in addition to tuition.
There are also Independent 529 prepaid plans that cover tuition at more than 250 private colleges and universities throughout the country. However these plan have various restrictions and relatively limited investment options.
529 college savings plans on the other hand are much more unrestricted and let you make deposits in an account you can draw on later to pay for eligible college expenses. You can usually choose among several or more investment options for this type of plan, such as mutual funds or money market funds.
And the value of your investment grows tax-free if used for eligible college expenses. If you withdraw money for other purposes, you will be liable for taxes and penalties. Think of a 529 college plan as a 401K plan for college expenses.
Unlike prepaid tuition plans, college savings plans do not allow you to lock in at today’s tuition rate. Your investment grows at a market rate and may lose value in an economic downturn, although some plans guarantee a minimum annual return.
But you can use the money in a 529 college savings plan at any college or university in the country and use it not just for tuition but for room, board, and any other eligible education related expenses.
Tips on choosing a 529 plan
Here are some tips that I found were helpful in finding the right plan:
- Start by looking into your state’s prepaid tuition plan. All fifty states and the District of Columbia sponsor at least one type of 529 plan. The plan in your state may have unique advantages for residents, such as an exemption from state income taxes for qualified withdrawals. Also check your local state’s 529 site for details on options, benefits and pricing (Google your state name and 529 plan).
- Before you start a serious search make a list of your child/families college needs, desired colleges/states and the amount you could contribute on a monthly basis towards a 529 plan. There is no point over extending your finances and taking on more debt just to contribute to a 529 plan.
- Consider a college savings plan or independent prepaid tuition plan if your child may need flexibility based on future moves across state lines or for special education needs. These plans may be good a option if you aren’t sure that the schools offered by state plans would suit your child.
- Make sure you understand the fees for college savings plans. Some college savings plans charge high fees, such as a “sales load” (a fee paid when you buy or sell shares) of as much as 6 percent and an annual administrative fee of 2 percent. If a fee is steep, you might be better off investing on your own or in another type of plan.
- The Securities and Exchange Commission (SEC) offers a list of questions to ask at and includes a chart comparing prepaid tuition and college savings plans, facts about how a plan may affect your child’s eligibility for financial aid, and links to lots of additional information.
If you look into a variety of plans, including some in your state, you’ll have the best sense of your options and how your child might benefit from them. The earlier you start the better and hopefully the above guidance can start you going in the right direction.