529 Plans Demystified: State Tax Benefits and Investment Options

The 529 plan is the most powerful college savings vehicle available. Tax-free growth, tax-free withdrawals for education, and state tax deductions in many states. But with 50+ plans to choose from, how do you pick the right one?

How 529 Plans Work

A 529 plan is a tax-advantaged savings account for education expenses. You contribute after-tax dollars, investments grow tax-free, and withdrawals are tax-free when used for qualified education expenses.

State Tax Benefits: The Key Decision Factor

While there's no federal tax deduction for 529 contributions, many states offer state income tax deductions or credits:

• Full deduction states: Some states (like Colorado, New Mexico, South Carolina) allow unlimited deductions
• Capped deduction states: Most states cap deductions at $2,000-$10,000 per beneficiary
• No income tax states: Alaska, Florida, Nevada, South Dakota, Texas, Washington, Wyoming have no state income tax - no deduction needed
• No benefit states: California and others offer no state tax benefit for 529 contributions

Your State's Plan vs. Other States

If your state offers a tax deduction: Using your state's plan often makes sense, even if investment options aren't optimal. A $5,000 contribution with a 5% state tax rate saves $250 immediately - that's hard to beat with better investment returns alone.

If your state offers no tax benefit: You can choose any state's plan. Look for low fees and good investment options. Popular choices include Utah's my529, Nevada's Vanguard 529, and New York's 529.

What to Look for in a 529 Plan

1. Low expense ratios: Look for total costs under 0.5% annually
2. Quality investment options: Low-cost index funds or age-based portfolios
3. No account maintenance fees: Many plans waive fees for residents or with e-delivery
4. Flexibility: Easy to change investments and beneficiaries

Age-Based vs. Static Portfolios

Age-based portfolios: Automatically shift from aggressive to conservative as your child approaches college. Set-it-and-forget-it convenience.

Static portfolios: You choose the allocation and manage it yourself. More control but requires attention.

For most families, age-based portfolios are the right choice. They ensure you're not taking excessive risk as college approaches.

Common 529 Mistakes

• Choosing your state's plan without comparing: If no tax benefit exists, shop around
• Overfunding: Non-qualified withdrawals face taxes and a 10% penalty on earnings
• Being too conservative: With 10+ years until college, aggressive allocations make sense early
• Not using the money: 529 funds can be transferred to other family members or rolled to Roth IRAs

The Superfunding Strategy

The gift tax exclusion allows you to contribute 5 years' worth of gifts upfront - $95,000 per beneficiary ($190,000 for married couples) in 2026. This "superfunding" maximizes tax-free growth time.

Grandparents often use this strategy: a significant gift that compounds for 18 years can fully fund a college education.