Dear Dr. Don,
My question is about use of the 529 plans to pay college tuition if there are no rules about the length of time the money must stay in the account. In Missouri, it appears there are no restrictions as to how long money must be in the account before you can make withdrawals to pay for school. Is it possible to funnel money through a 529 to gain the state tax deduction?
-- Becky Bounty
If you are late to the game in terms of saving for your children's college education, you still may be able to realize tax savings if your state offers a tax deduction or credit for contributions to a section 529 college savings plan. The state of Missouri did have a requirement that the money had to be in the account for 12 months. Since then, it has passed legislation to remove that requirement. However, it does have a requirement that the money be in the account for 10 days.
The tax savings will be reduced by any fees and expenses you pay in the account. That may include investment management fees and annual account fees. For this to make economic sense, the credit or deduction has to be greater than those fees. Some states allow up to $26,000 in annual contributions with a tax deduction for those contributions. Other states have lower contribution limits for the deduction.
For Missouri residents, an individual can deduct contributions of $8,000 per year from his or her taxes, and a married couple filing jointly can deduct up to $16,000 per year. These contributions are deductible in computing your Missouri adjusted gross income. This assumes the individual is the account owner. This is only for new money contributions and not for rollover contributions. Contributions have to be made or postmarked by the end of the tax year. The section 529 plan doesn't have to be Missouri's college savings plan.
Not all states offer a tax deduction for contributions to a 529 college savings plan. If your state does, and you want to set up a 529 plan to capture the tax savings, talk to the plan administrator about minimum holding periods in the account. If your money won't be in the account for long, it's a bonus if you don't have to invest the money prior to distribution and can avoid the investment management fees.