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January 12, 2016

Tax Deductions for 529 Plans Outside of Your Resident State

A 529 plan is a tax-advantaged savings plan which is aimed towards encouraging saving for education expenses. These plans are sponsored by states and, in some cases, private educational institutions. Many taxpayers wonder whether or not they can contribute to a state plan outside of the state they reside in and the answer is yes, but it may affect your tax deductions. New to the Tax Cuts and Jobs Act, you can now save for primary AND secondary education with a 529.

Most 529 plans have no state residency requirements, so it creates an open market to shop around for the plans each state has to offer. But, as with most things in life, some research needs to be done before making a decision to take your 529 dollars elsewhere. Each state will offer different options for investment which will yield varying rates of return, as well as, varying levels of fees and expenses associated with the options. Most residents choose to opt for an in-state plan, but it’s important to consider whether the state offers an income tax deduction for contributing. If the resident state does not offer an income tax deduction, it’s important to instead focus on fees, expenses and investment objectives. Every state allows a rollover to another 529 plan once per year with no tax consequences, but several states will charge for transferring an account or recapture state tax deductions when moving from an in-state to an out-of-state plan.

Thirty-four states offer tax deductible plans to their residents. However, moving your 529 dollars to a different state may cause you to lose the tax benefits associated with the plan. For example, Illinois allows only contributions to an Illinois 529 plan of $10,000 (filing single) and $20,000 (married filing jointly) to reduce taxable income. Qualified distributions from only an Illinois 529 plan are exempt. On the other hand, in Missouri, residents can contribute up to $8,000 (filing single) and $16,000 (married filing jointly) to a Missouri 529 Plan or another state’s 529 plan and reduce taxable income. Likewise, qualified distributions are exempt whether it is a Missouri or a non-Missouri 529 plan. So, compared to Missouri, Illinois incentivizes its residents to keep dollars in the state and allows higher contributions, whereas Missouri allows more freedom to choose where to put your 529 dollars while still allowing deductions.

To avoid abuse of these plans by trying to set up tax-shelters, the states keep a watchful eye and have certain consequences to protect their 529 funds. If someone is caught contributing money to these plans without the intent of using it for education, they risk having their account terminated and open themselves up to extra penalties.

In the end, where you put your money is up to you. Educate yourself on your state’s rules regarding contributions to a 529 plan and keep in mind many states are similar to Illinois, and will only incentivize residents to contribute to their home state. As you begin your journey of saving for education, do your research and contact an Anders advisor.

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