About half of all states allow residents to take state income tax deductions for contributions to 529 plans. Thus, if you put $100,000 into a 529 plan for your daughter, you’d deduct $100,000 from your taxable state income.
If your state offers a deduction, you need to look at the fine print. There may be a cap on the amount you deduct. New York, for example, limits this deduction to $5,000 a year, or $10,000 on a joint return. You and your spouse, therefore, would have to spread contributions over 10 years in order to get a $100,000 deduction. In some states, limits may be much lower, with excess amounts carried forward to future years.
You should put a value on this deduction. If you live in a state where your tax rate is 10 percent, a $10,000 tax deduction could save you $1,000 per year. However, paying an extra $1,000 in state income tax would give you an extra $1,000 to deduct on your federal tax return, so the net tax benefit of staying in-state would be around $700 per year, in this example. You’d need to see if other states’ 529 plans have other benefits (better investment choices, for example) that outweigh the tax savings.
