Does it make sense to start a 529 savings plan for my daughter if she is starting college this year?
As with answers to many financial questions, it depends. Although there are many benefits to starting a 529 savings plan, the best financial reasons are related to the income tax benefits associated with contributing to and taking distributions from a 529.
529 plans offer federal income tax benefits and, depending on the state in which you reside, state income tax benefits. For federal tax purposes, funds contributed to a 529 plan grow tax deferred. In addition, distributions for qualified educational expenses are free from federal income taxes. For state tax purposes, certain states offer income tax benefits for their residents who fund a 529 plan in their state. These benefits often include the ability to deduct some or all of their contributions or the ability to claim a tax credit for their contributions.
In general, starting a 529 plan for a child who is in college or about to start college minimizes the benefits from the tax deferred growth offered by 529 plans. This is largely true because you will need to withdraw the funds contributed before there is sufficient time to accumulate any growth on those contributions.
However, you may still receive a state tax benefit if your state offers one. The actual amount of benefits you can receive will depend on whether your state offers a tax deduction or a tax credit, the amount of your contributions, your marginal state tax rate, and the provisions of the 529 plan. For example, New York State allows residents to deduct up to $5,000 of their 529 contributions ($10,000 for couples who are married filing jointly) and allows tax-free withdrawals for qualified higher education expenses. If you are in the 6.85% NY state income tax bracket, a $10,000 contribution could yield $685 in savings.
Keep in mind that some 529 plans have waiting periods between when contributions are made and when those funds can be withdrawn in order to receive the state tax benefits offered. If your 529 plan has a waiting period, it may still be beneficial to establish and fund the account if you can work out the timing of your contributions and withdrawals to satisfy the plan’s specific requirements.
For more information on your state’s 529 plan, visit http://www.collegesavings.org/index.aspx.
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