Families have many variables to consider, including plan quality, state income tax deductions, and contribution amounts.
Investing in a 529 college-savings plan allows you a significant break on your federal taxes: tax-free compounding and withdrawals, provided the money is used for qualified college expenses. Most 529 plans also offer some sort of a state tax break on contributions by in-state residents, usually a deduction but sometimes a credit.
There are no one-size-fits-all answers about whether to stay with your home state's plan or pursue one of the best plans available nationally. To reach a good decision, you'll need to weigh how much you're saving in taxes by staying in-state alongside the potential costs you'll incur if you invest in a subpar plan.
Understanding Your State Tax Break
To reach a sound decision, the starting point is to find out just what kind of a tax break your state offers 529 savers--or doesn't.
Usually, investors in 529 plans can deduct at least a portion of their contribution amount from their state income taxes if they invest in their own state's plan. Naturally, state tax benefits associated with 529 plans depend on where the investor lives. Some states offer quite generous 529-related tax benefits, while others offer no benefits at all.
In general, state tax benefits for 529s can be aggregated into a few different buckets, listed below. Some states don't follow these patterns (for instance, they offer a tax credit instead of a deduction), but these cases are few and far between. (Note: Utah residents can claim a credit for their 529 contributions, up to $184 per beneficiary for a married couple filing jointly. Indiana residents can claim a 20% tax credit on contributions, up to a maximum credit of $1,000.)
No tax benefits: Some states offer no tax benefits for investing in a 529 plan. This can either mean that the state offers no tax deductions for 529 savings or that the state does not collect any income tax at all. The following states offer no tax benefits for investing in a 529 plan.
States with No Tax Benefits
|States With No Tax Benefits|
Tax parity: Tax parity is an interesting inversion of a state having no tax benefits. In this instance, the states are aiming to give their residents the incentive to save for college, period, rather than the incentive to invest in their home state's 529 plan. States that offer tax parity provide state income tax benefits for resident 529 savers regardless of which state's 529 they use. This means that a resident of Missouri (one of the tax parity states) can invest in a 529 plan in Virginia while still collecting Missouri's state income tax deductions for 529 savers.