Give the Gift of a 529 Plan Contribution

If grandparents make contributions to their grandchildren's 529 plans -- which are owned by the parents -- do they still get the state income-tax deduction if offered by their state? Also, do they have to reside in the same state?

This is the perfect time of year to think about making 529 contributions as holiday gifts for your grandchildren. And it’s also a good idea to consider the tax benefits you could receive.

The rules vary by state. Most states require you to contribute to your home-state’s 529 plan in order to get an income-tax deduction for your contributions. In that case, you can only deduct your contributions to the parents’ 529 if they set up the account in your state. (Five states -- Arizona, Kansas, Maine, Missouri and Pennsylvania -- allow a deduction for contributions made to any state’s plan.)

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States have different rules about who can qualify for the tax break. Some states, such as New York, let you take a tax deduction for your contributions only if you are the owner of the account. But other states, such as Connecticut and Kansas, allow nonowners to take the deduction, says Joe Hurley, of Savingforcollege.com. And in Virginia, the account owner can claim a deduction for contributions made by nonowners, says Hurley.

But even if you aren’t eligible to deduct your contributions to an existing account owned by someone else, you may be able to get a tax deduction by opening a new account for your grandchild. There’s no limit to the number of accounts that can name the child as a beneficiary. If you live in a different state than the child’s parents, for example, you could open an account in your own state and make tax-deductible contributions to that account, even if the parents already have an account for your grandchild in another state. Or you could open a separate account in your state if the tax deduction is only available to account owners, even if the grandchild is the beneficiary of another account in your state.

Check out the rules for the tax deduction and the size of the deduction permitted in your state at www.savingforcollege.com -- click on “compare plans” and focus on the tax section. Also review the deadlines for making tax-deductible contributions -- most states require you to make contributions before December 31 to qualify for a tax break for that calendar year, but a few states (such as Georgia) give you until the tax-filing deadline (April 18 in 2011) to qualify for a 2010 tax break.

For more information about Kiplinger’s favorite 529 plans, see Find the Best 529 Plans.