Saving for College the Smart way - 529 Plans

529 plans are a great way to save money over the long term for your child’s education. But there’s a huge tax benefit for people who’s kids or grandkids are already in college or starting this fall. This loophole works for people who live in states with state income tax benefits on their 529 plans.

Here’s an example, as illustrated by the Charleston Post and Courier. Say you have a tuition bill due in a couple weeks for $10,000. You can contribute $10,000 today to your child’s 529 account, and then withdrawal it next week to pay the tuition bill. South Carolina’s 529 plan offers a state income tax deduction for contributions to a 529 plan, so you would be able to deduct $10,000 from your income on your state income tax return this year even though you only had the money in your 529 account for a week.

Many other states also have this loophole because there’s no waiting period for getting the deduction. Of course, this doesn’t have anything to do with federal tax benefits of 529 plans, so it only applies if you live in a state with a 529 plan offering upfront tax benefits with no waiting periods.

Money Magazine has a new article, just published on CNN.com, about 529 plans. It asks if 529 plans are still the way to go. The answer: absolutely, except in very rare circumstances:

The tax breaks usually make 529s unbeatable. Say you’re in the 28% tax bracket, have a five-year-old and save $200 a month in Utah’s low-cost 529, which has annual expenses of 0.38%. Assuming annual average returns of 5%, you’ll have $39,100 by the time your kid is 18. Invest the same amount in a taxable account with equal fees and returns, and you’ll have $36,200 after taxes. In other words, you’ll lose $2,900.

The 529 comes out even further ahead if your state allows you to write off all or part of your contributions (33 states and the District of Columbia will let you do that).