Get a Break on College Costs

Some people have been stashing money in 529 college-savings plans since their kids were in diapers. But even if you procrastinated and your child is already enrolled in school, contributing to a 529 account could save you hundreds a year.

The tax perks vary from state to state. Twenty-six states and the District of Columbia offer a state income-tax deduction for contributions to 529 plans that they sponsor (see our map for all the states that offer tax breaks). Five states -- Arizona, Kansas, Maine, Missouri and Pennsylvania -- offer a state-tax deduction for contributions to any 529 plan. Indiana, Vermont and Utah offer a state-tax credit for contributions to their state-sponsored plans. (A tax credit is more valuable than a deduction because it reduces your taxes dollar for dollar.) In addition to the state-tax benefits, earnings on your plan investments are tax-free if they are used to pay qualified expenses, such as tuition, books and fees.

How much you will save by making last-minute contributions depends on your tax bracket and the plan’s contribution limit. But the savings can be substantial. For example, if you are in the top, 6.85% tax bracket in New York, you will save $685 per year by contributing the annual maximum of $10,000 for joint filers to the state’s 529 plan and then withdrawing an equal amount to pay for current college expenses.

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Not all plans are as generous, however. Two states that offer state-tax deductions pose problems for last-minute contributors. Michigan provides a deduction for net contributions, meaning your contributions minus your withdrawals. So if you contributed to Michigan’s 529 this year, you would have to wait until 2011 to withdraw the money to get the full deduction. Montana recaptures any state-tax deduction on withdrawals made within three years of opening the account.

If you use this late-contribution strategy, park your investment in the 529 plan’s most conservative option to protect the money from stock-market volatility. Plus, conservative alternatives, such as CDs and money-market and stable-value funds, charge the lowest fees among investments on a plan’s menu.

See our state-by-state list of 529 plans that make it easy for last-minute contributors.