In This Issue...
- Claiming a state income tax deduction
- Kudos for "The Book"
- Scholarship of the month

Claiming a state income tax deduction
by Joe Hurley, founder, Savingforcollege.com
Does your state offer a state income tax deduction (or tax credit) for 529 contributions? Twenty-eight states and the District of Columbia currently do. All but one of them (Pennsylvania) require that contributions be made to the state's own 529 plan to be eligible for the deduction. Here's a short guide on how to take best advantage of this particular benefit on your 2006 state tax return.

• Be sure you understand what your state offers and its requirements and restrictions. Visit your state's 529 plan website and download the official disclosure statement which will describe the special state tax benefits. You can also view our own description of the benefit on the plan description page at savingforcollege.com. Most states place an annual cap on the amount of the deduction but in some cases permit excess contributions to be carried over to future years. A couple of states impose income limits.
• Determine if your state's rules are changing and how those changes may impact the timing and amounts of your contributions. If you live in Indiana, an Indiana tax credit for contributions to Indiana's 529 planbegins in 2007. Maine also starts up with a small deduction in 2007, applicable to contributions made to any 529 plan. Kansans can claim a deduction for contributions to a Kansas 529 plan in 2006, and to any state-sponsored 529 plan beginning in 2007. In North Carolina and Vermont, the benefit caps will increase in 2007.
• Consider the value of the state tax benefit in selecting a 529 plan. How much will you be losing by choosing an out-of-state 529 plan, and what level of investment performance in an out-of-state 529 plan will make up for the lost tax savings? The answer will depend on your state tax bracket, the amount of your contributions relative to the maximum deduction amount in your state, your ability to itemize deductions on your federal income tax return, and the number of years your money will stay invested in the 529 plan. We offer an easy and comprehensive calculator called the State Tax 529 Calculator for financial professionals under our premium subscription service.
• The state tax benefit is worth more for parents with older children than for those with young children. To demonstrate this concept, we plugged a set of assumptions into our State Tax 529 Calculator, using New York as our example state, and varied just one factor: the number of years invested in the 529 (based on the age of the child.) The annual return equivalent of the New York tax deduction for a 5-year old (13 years to withdrawal) was only 0.41%, but the annual return equivalent for a 15-year old (3 years to withdrawal) was 1.79%. A New Yorker with an investment horizon of just 6 months, for example, would find the value of the in-state deduction nearly impossible to beat through investment performance in a non-New York 529 plan.
• Many other factors beyond the state tax benefit can influence your choice of 529 plan. Some states also offer their residents matching contributions, state financial aid preferences, or special asset protections with the in-state 529 plan. On the other hand, out-of-state 529 plans may provide you with higher-returning investment options, lower expenses, and/or fewer restrictions. We've developed a 529 Plan Selection Checklist which you can get for free by clicking on any of the 529 plans participating in our "Get Started" enrollment and information service. (The checklist is partially completed for the plan you select.)
• Make your contribution on time if you are planning to claim a deduction on your 2006 state income tax return. Be sure you comply with the deadline mandated by your state. Some states allow contributions to be postmarked by December 31 while others require that contributions be received by the state on or before before the last business day of the year. A couple of states allow a deduction this year for contributions made by April 15 of next year.
• Rollovers require special attention. Some states permit a deduction for incoming 529 rollovers while others do not. Some states impose "recapture" tax on outgoing 529 rollovers while others do not. Depending on where you live, careful rollover planning may allow you to capture a state tax deduction even when your money spends most of its time in an out-of-state 529 plan.

Color of Money Book Club selects "The Best Way to Save for College"

We're happy to see our book "The Best Way to Save for College - A Complete Guide to 529 Plans (2007 Edition)" selected by nationally-syndicated finance columnist Michelle Singletary as her December pick for the Color of Money Book Club. Singletary devoted a recent column to a review of the book and a discussion of 529 plans. Due in large part to this selection, Amazon.com is currently out-of-stock but is in the process of replenishing their inventory. You can still order the book directly through us for immediate shipment.

Joe Hurley will be joining Michelle Singletary for an online discussion on Thursday, January 4 at noon. You can access the discussion through the Washington Post website.

Scholarship of the Month
College Matters Scholarship is open to high school graduates or students in their last year of high school who plan to enroll full time in a four-year college or university the following fall. Along with a demonstration of academic success and leadership, financial need is a significant factor in selecting recipients. Students will win scholarships ranging from $1,000 per year to $5,000.

Each month we feature a particularly interesting and generous scholarship opportunity. Savingforcollege.com has no relationship with the scholarship provided.