In Some States, New Benefits for 529 Savers

Parents and grandparents often turn to state 529 savings plans to sock away money for a child’s future college costs. But many states recently have made changes to their programs, and with the tax-filing deadline fast approaching, savers who don’t pay attention may miss out on the full benefits of such accounts.

Money contributed to a 529 (named for the section of the federal tax code which authorizes them) is not deductible from federal income taxes, but the investment grows tax-deferred. There are two types of 529s: 529 savings plans, which are similar to a 401(k) plan or Individual Retirement Account (IRA), in that a saver invests in mutual funds or similar investments; and prepaid plans, which allow savers to pre-pay all or part of the costs of an in-state public college education, to avoid future price increases. In many cases, the money in a prepaid plan also may be used at private and out-of-state colleges.

The plans are operated by states or educational institutions. They are available in all states but Wyoming, and 30 states and the District of Columbia allow savers to take state income-tax deductions for 529 contributions.

Some states have annual limits on how much you can deduct, ranging from $250 per individual tax filer in Maine to $10,000 in Illinois. Other states limit deductible contributions to a percentage of income, or set lifetime contribution limits. South Carolina allows savers to deduct the most in state income taxes over the lifetime of the beneficiary, a total of $370,000, according to Joe Hurley, founder of SavingForCollege.com and a leading expert on the accounts. Three states – Indiana, Utah and Vermont – offer tax credits.

With college costs exploding, many states are trying to convince more people to make use of 529 plans. For example, earlier this month, Maine announced that it will partner with the Portland-based Alfond Scholarship Foundation to open up 529s, with initial investments of $500 in each account, for each baby born in the state. Colleen Quint, president and CEO of the foundation, said the $500, which will be invested in a mutual fund, might triple over 18 years. The foundation, which has about $700 million in assets, expects to give the money to about 12,000 babies annually, Quint said.

Though $1,500 wouldn’t go very far in paying for a private four-year college, it would make a dent in community college or trade school costs (at least at current prices).

Before this month, the Alfond Foundation gave $500 to every family that opened a 529 account within the first year of the baby’s birth, but the family had to act first. A similar law in Rhode Island calls for the state to pony up $100 for every family that opens a 529 for a newborn.

Other states are also moving to enhance their 529 plans, including:

– Arizona, which last year increased the maximum deduction for 529 contributions from $750 to $2,000 for individual filers and from $1,500 to $4,000 for joint filers, effective for the year ending Dec. 31, 2013.

– Nebraska, which increased the deduction from $5,000 to $10,000 for individuals and married couples filing jointly, and from $1,500 to $5,000 for married people filing separately, beginning in 2014;

– Oregon, which in 2013 removed a restriction prohibiting accounts with the same owner and beneficiary from participating in both of Oregon’s 529 college savings plans, one sold directly by the state and another sold by brokers.

– Wisconsin, where the legislature approved a bill which would let taxpayers carry a tax deduction into the next tax year. The state limits deductions to $3,000 annually, so if a contributor put $4,000 into the 529 account, then $1,000 of that deduction could be used in the next tax year. Republican Gov. Scott Walker is expected to sign the bill.

– Montana, where Democratic Gov. Steve Bullock signed a bill last year that made taxpayers’ contributions to a non-Montana 529 plan eligible for a state income tax deduction. The change was effective for all of 2013. Montana joins Arizona, Kansas, Maine, Missouri and Pennsylvania in allowing taxpayers to take a deduction no matter where they open a 529 account.

“It’s a competitive marketplace, so you don’t have to use your own state’s plan,” Hurley said. “Feel free to shop around.”