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How a Move Can Change Your 529 Plan Tax Deduction

The tax deduction you get for contributing to your state’s 529 plan can disappear if you move to another state.

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QWe opened a 529 college-savings plan in our home state of New York for a grandchild. But early this year, we moved to Idaho. Can we continue to deduct our contributions to the 529 on our Idaho income tax return?

AYou won’t get an Idaho state income tax deduction for contributing to the New York 529 plan. You can, however, qualify for an Idaho income tax deduction of up to $6,000 per year (or $12,000 for married couples filing jointly) if you open an account with the Idaho 529 plan and contribute to it. You can keep your New York 529 plan or roll the money over to the Idaho plan.

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Whenever you move, check out the rules for deducting 529 contributions in your new state. Thirty-four states (and the District of Columbia) offer income tax deductions or credits for contributing to their 529 plan, but only seven states allow tax breaks for contributions to any state’s 529 plan (Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana and Pennsylvania), says Mark Kantrowitz, publisher of Savingforcollege.com. Idaho residents can receive a tax break only if they contribute to Idaho’s 529 plan.

Also, find out the state’s rules for who must own the plan to qualify for a tax break. Most states that offer a tax deduction let any resident deduct their contributions. In Idaho, for example, you don’t need to be the account owner to deduct your contributions. That means you could take a deduction if the parents have a 529 account in Idaho for your grandchild and you contribute to that. However, a few states, including New York, allow only the account owner to deduct contributions. (There’s no limit to the number of 529 accounts you can have for one beneficiary.)

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Of course, you can just keep your money in the New York plan until the student needs it. Besides, if you roll over the money from the New York 529 to the Idaho plan, you could lose the state income tax benefits you received before your move. “New York will recapture any state income-tax benefits previously received if the New York 529 plan is rolled over to another state’s plan, so it is best to leave the money in the New York 529 plan,” Kantrowitz says. New York is one of 19 states that do this. But you can still use the money in your former state’s 529 tax-free to pay for college in any state. For more information about each state’s rules, see the Research & Compare 529 Plans page at Savingforcollege.com.

Also as a grandparent, keep in mind the potential financial aid implications when opening a 529 account for a grandchild. “A grandparent-owned 529 plan is not reported as an asset on the Free Application for Federal Student Aid (FAFSA), but distributions count as untaxed income to the beneficiary, reducing eligibility for need-based financial aid by as much as half the distribution amount,” says Kantrowitz. Parent-owned 529s, on the other hand, are reported as a parent asset on the FAFSA, reducing aid eligibility by no more than 5.64% of the 529 account balance, and distributions are ignored.

To avoid the financial aid hit for grandparent-owned 529s, the college student can delay withdrawing money from the account until after January 1 of his or her sophomore year, says Kantrowitz. That way, the distribution won’t be reported on the FAFSA if the student graduates in four years. Or you may be able to transfer ownership of the account to the parent, or roll over a portion of the money to the parent’s 529 account each year when the college tuition bill comes due, he says.

SEE ALSO: 6 Tax Breaks for College Costs

Got a question? Ask Kim at askkim@kiplinger.com.