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I am a bit confused. If I live in Virginia and purchase a 529 college-savings plan offered by the state of Iowa, can I deduct my contribution?
No, to get a state income tax deduction, you need to live within one of the 26 states that offer a tax deduction and must buy your own state's plan. Both Iowa and Virginia offer state income tax deductions for their residents who sign up for their own plans.
If you were an Iowa resident and signed up for that state's plan, for example, you could deduct up to $2,375 per beneficiary per year. Iowa's is always one of our favorite 529 plans, with low fees and investments managed by Vanguard.
But because you're a Virginia resident, you would get a state income tax deduction only if you signed up for Virginia's own 529 plan. Virginia residents can deduct up to $2,000 per year per account and carry the deduction forward for an unlimited number of years if they have contributed more than that (a $6,000 contribution, for example, could get you the full $2,000 deduction for three years). The $2,000 cap on annual deductions doesn't apply to investors age 70 and older, who can deduct their full contributions in one year.
Virginia offers two types of 529 plans (in addition to a prepaid tuition plan). The Virginia Education Savings Trust is sold directly to investors and offers several investing options -- including a variety of age-weighted portfolios that invest in mutual funds from Vanguard, Invesco, American Funds and others. The Virginia CollegeAmerica plan is sold by financial advisers -- our favorite among adviser-sold plans -- and is invested in American Funds.
The good news is you can transfer your savings once per year. And if you move your funds out of Iowa to Virginia, you'll get Virginia's $2,000 deduction and carry-forward. Contact the Virginia College Savings Plan to get the forms you'll need to make the transfer. Because many states continue to improve their plans, or change their tax policies, it's smart to check out the options every year or so.
When looking into 529 plans, first check on your state's income tax deduction. If the plan has reasonably low fees and good investment choices, that may be your best bet. If you like another state's plan better, consider contributing just enough to your state's plan to get the full state income tax deduction, then investing the rest of your money in another state's plan.
Also be wary if a financial adviser tries to sell you a 529 plan from another state. The NASD recently fined Ameriprise Financial Services (formerly American Express Financial Advisors) $500,000 for failing to adequately supervise the firm's sales of 529 plans, and required Ameriprise to pay about $750,000 to compensate more than 500 customer accounts affected by those supervisory failures.
The NASD investigation found that from May 2001 through October 2003, Ameriprise only sold one type of 529 plan -- the one sponsored by the state of Wisconsin -- even though 32% of its sales were to customers who lived in other states that offered state income tax deductions for contributions. Because they ended up contributing to the Wisconsin plan, rather than their own state's plan, they did not get any state income tax deduction.
For more information about 529 plans, see Kiplinger's Find the Best 529 Plan search and comparison tool. Just click a state for plan details or compare by plan type or question. For help comparing 529 plan fees, see the NASD's 529 expense analyzer, and see the NASD's School Yourself Before You Invest about areas to be cautious about when selecting a plan.
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