For all the risks that come with investing in 529 college savings plans in a period of market tumult, investors in most states have one certainty: that they'll receive state tax benefits for their contributions to their home state's plan. But those tax savings are much richer in some states than in others, as these figures for one hypothetical family show.
529 Plans and Taxes
See a chart of the state-tax savings for a couple filling a joint 2011 return with $100,000 in taxable income and contributions of $2,500 each to two children's in-state 529 savings plans.
Investors make roughly a third of their contributions to the state-sponsored 529 plans during the fourth quarter of each year, and most of that money comes rushing in during December as families look ahead to tax season, says Paul Curley, director of college-savings research at Financial Research Corp. in Boston.
Most states offer a tax deduction. For one child, a married couple's annual write-off is capped at levels ranging from $250 (in Maine) to $26,000 (in Pennsylvania), says Joe Hurley, founder of Savingforcollege.com, which tracks 529 plans. Four states -- Colorado, New Mexico, South Carolina and West Virginia -- don't have annual deduction limits, but cap total deductions over time for each child. The limit can be as much as $318,000 (in South Carolina).
For parents saving for two children's college education, the annual deduction caps in 10 states double. In Kansas, for example, it's $6,000 for one child or $12,000 for two.
Instead of deductions, three states -- Indiana, Utah and Vermont -- give tax credits for a portion of 529-plan contributions.
Sixteen states don't offer any tax benefits. To be sure, a few are states that don't have a personal income tax, such as Florida and Texas. But several of those states, including California, Hawaii and Minnesota, have high tax rates.
Beyond tax benefits, some states are offering free cash in their 529 plans. While most have income limits, some give money just for starting a 529 plan. For example, Maine and Rhode Island offer $500 and $100, respectively, for parents who start a 529 plan before their child's first birthday.
One drawback: Because the tax benefits are typically limited to plans sponsored by the taxpayer's state, that can stop people from choosing a different 529 plan with better-performing investments, says Deborah Fox, a San Diego-based financial planner and founder of Fox College Funding. The exceptions are Arizona, Kansas, Maine, Pennsylvania and Missouri, where residents can choose a 529 plan from any state while still receiving their own state's deduction.—Ms. Andriotis is a reporter for SmartMoney.com. Email her at email@example.com.