sunset provision which would have cancelled that tax-free status as of the end of 2010. And perhaps the best news of all? For your contributions, the majority of states serve up juicy tax breaks that can help enormously. So while contributions are made with after-tax money, unlike a 401(k), you will get some help on your annual state tax return. In New York, for instance, an individual can write off up to $5,000, a couple, up to $10,000. Heck, some states even chip in matching funds. It may not be a huge sum—Colorado, for instance, matches dollar-for-dollar up to $500 annually for lower- to _middle-income state residents. But hey, it’s free money.
To take full advantage of these provisions, though, you can’t delay saving too long. “Start as early as possible, and make it a part of your budget just like your mortgage or car payments,” says Kevin Pritchett, head of Kevin Pritchett & Associates Retirement Planning in Westchester, Illinois. “But not all 529 plans are the same, so you need to do your research.”
The State of Saving: Where to open a 529
Your plan isn’t at all constrained by where you live. A _California resident, for example, could invest in Utah’s 529, or Florida’s, or any other state’s plan. But tax deductibility and other benefits are almost always for in-state participants, so “first look to your own state’s plan,” suggests Williams. (Exceptions offering deductibility for out-of-state contributions include Kansas, Maine, and Pennsylvania.) Ideally, your state will boast a strong-performing roster of funds in its 529. But even if performance is only middling, it probably still makes sense to stick with it if it offers a significant state tax deduction. That’s because although you might increase your rate of return slightly by going out of state, you might also be giving up a massive break on your annual tax return.
Atlanta’s Sam and Kesia Hudson ended up opting for Georgia’s 529, because it made the most sense for them. First, it has racked up decent performance (its mutual funds are all rated three stars or higher by Morningstar) and is steered by respected firm TIAA-CREF. And second, Georgia offers a state income tax deduction for residents up to $2,000 per beneficiary. With two future college grads under their roof—daughter Sierra, 6, and son Sam, 4—they couldn’t pass that up. “These days, a 529 is pretty much mandatory, not even optional anymore,” says Sam, 37, an engineer. “But with the state tax deduction and only a small amount—$20 per week, per child—coming out of my paycheck every week, it’s worked out really well.”
If your state’s 529 doesn’t feature such nifty tax benefits, then feel free to start shopping around. At the popular information site Savingforcollege.com, you can peruse the relative performance of every state’s investment offerings. To help you narrow the search, mutual fund researcher Morningstar puts together an annual report of the nation’s 529s, which is available at Morningstar.com. Top performers in its most recent report: Colorado Scholars Choice, Maryland College Investment