Invest in Your State's -- or Another's -- 529 Plan?

My husband and I are new parents, and we want to start a 529 college-savings plan for our baby. We live in Virginia, and we’re on a strict budget. Should we contribute to our state’s 529 plan, or would another state’s plan be a better choice?

You are smart to start thinking about saving for college when your child is so young. Even on a limited budget, setting aside a small amount of money every month can add up to a significant amount by the time your child reaches college age. If you start investing $200 per month and continue adding to the account at that pace for 18 years, for example, you could amass more than $78,000 by the time your child is ready to start college, assuming your investments earn a modest 6% per year. All of that money can be used tax-free for college costs. Opening a 529 makes it easy for grandparents and relatives to add to the account, too, for birthdays, holidays and other special gifts.

We generally recommend that if your state offers an income-tax deduction, you contribute to your own state’s plan. You’re lucky to live in Virginia, where residents can get a tax break for their contributions to Virginia’s 529 accounts. About half of the states offer an income-tax deduction for contributing to a 529, and five states -- Arizona, Kansas, Maine, Missouri and Pennsylvania -- give you a break for contributing to any state’s plan.

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You can deduct up to $4,000 in contributions to Virginia’s 529 from Virginia income taxes each year, and you can carry forward any excess contributions to future years (if you contribute $5,000 in one year, for example, you can deduct $4,000 in that year and the remaining $1,000 the next year). This annual limit is waived for people who are age 70 and older; they can deduct their full contributions -- even above the $4,000 limit -- in one year.

To qualify for the tax deduction in Virginia, you must be the owner of the account. In fact, if other people contribute a 529 account that you own, you can take a deduction for their contributions, too. If other relatives who live in Virginia want to get a tax deduction for their contributions, they can open up a separate 529 for your child and be the owner of that account; there’s no limit to the number of 529s that can benefit one child. Each state has different rules about who can deduct the contributions. For details about each state’s rules, see SavingForCollege.com. Also see Find the Best 529 Plan for a list of our favorite plans and recommendations for each state.