One popular method of saving for college is the 529 plan, with most states offering at least one option. With a 529 plan, your college savings grow tax-deferred, and you pay no federal tax on withdrawals for qualified higher education expenses.
In 2018, the Tax Cuts and Jobs Act took effect, expanding the definition of qualified higher education expenses to include tuition payments for private or religious school education from kindergarten through grade 12.
Here's what else you need to know about 529 plans and how they differ from state to state.
Federal Deductions for 529 Plans
There is no federal deduction for contributions to a 529 account. At the federal level, contributors should keep in mind that contributions may be subject to the federal gift tax laws. In tax years 2020 and 2021, you can give up to $15,000 to someone before the gift tax kicks in ($30,000 for married couples combining gifts).
At the state level, many states offer a deduction, and a few states offer a credit. Deductions typically will only be relevant if they help the contributor bypass the state’s standard deduction level. Credits offer the greatest advantage as they are subtracted from the amount of tax a taxpayer owes overall.
The Best 529 Tax Advantages Offered
Seven states offer a tax parity that allows taxpayers to receive a state tax break on contributions to any 529 plan in the U.S. Four states offer tax credits. States with tax parity and tax credits make them obvious front-runners for the best advantages.
Tax Parity Deductions
Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana, and Pennsylvania are the seven states that offer their residents tax deductions in the 2020 tax year for contributions to any state’s 529 plan, not just their own. This gives residents of these states the freedom to pick and choose among state plans—seeking out those with the lowest fees and the best investment options—while still getting a state tax deduction.
Out of these seven states, the best may be Pennsylvania's 529 College and Career Savings Program (PA529). This plan allows a deduction of up to $15,000 for individual filers. For a married couple filing jointly, the deduction cap doubles for a total of $30,000.
Indiana, Utah, Vermont, and Minnesota are the four states offering a tax credit, which include the following:
- Indiana: Any contributor can claim a 20% tax credit on contributions up to $5,000 for a maximum credit of $1,000.
- Minnesota: Any contributor can opt for either a 50% credit of up to $500 (regardless of filing status) or a deduction of $1,500 (for individual filers) or $3,000 (for those filing jointly).
- Utah: The contributor can claim a 5% tax credit per beneficiary on contributions up to $2,040 (for individual filers) or $4,080 (for those filing jointly) for a maximum credit of $102 (individual) or $204 (joint).
- Vermont: The contributor can claim a 10% tax credit per beneficiary on contributions up to $2,500 (for individual filers) or $5,000 (for those filing jointly) for a maximum credit of $250 (individual), $500 (joint).
Other States That Offer Deductions
As for the rest of the states with tax savings, you can only deduct amounts contributed to a state plan where deductions are available. Therefore, the best states from a tax perspective will be those that offer the biggest deductions.
While most states have dollar limits on 529 deductions, Colorado, New Mexico, South Carolina, and West Virginia allow you to deduct the full amount of contributions to their respective 529 plans. However, Colorado limits deduction amounts to the taxpayer's total taxable income.
States with No Tax Savings
Some states have no deduction or credit for 529 plan contributions. If you are a resident of one of these states, there are still plenty of 529 plan options but no tax breaks for utilizing them.
If you live in one of these states, your best option is to choose a state plan that has low fees and offers the type of investment options you want. In most cases, you do not need to be a resident of a state to invest in a state plan.
Even if you don't get upfront tax breaks from your state for contributing to a 529 plan, you will still get federal tax benefits down the road as long as you withdraw from them properly.
Which State Plan to Choose
Tax deductions and credits are great, but they may not add up to much if your state’s 529 plan charges high fees. Be sure to check on the fees for your state’s plan (and whether it waives those fees for in-state residents). Shop around and compare those fees to those of other states. Other important considerations are investment performance and whether the plan includes investment options, such as target-date funds.