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 When considering saving for college, there are many ways and options suggested by a variety of sources. One strategy is to invest in a 529 college savings plan. Pennsylvania has added additional incentives for investing in a 529 plan by giving state residents a tax deduction for contributions and not taxing withdrawals used for education purposes. To encourage savings, the IRS allows for tax deferred earnings growth and tax free withdrawals. However, contributions are not deductible on federal income tax returns.
Recently the Pennsylvania State Legislature decided to give residents two tax incentives to save money for college, even if you use an out-of-state plan to do it. A new law signed this summer provides a tax deduction for contributions to 529 college savings plans and eliminates state taxes on some withdrawals from out-of-state accounts as long as they are used for legitimate education expenses.
Funds in the 529 accounts grow tax-free and the withdrawals are not subject to federal and Pennsylvania State taxes as long as the money is used for qualified education expenses.
The Pennsylvania state deduction applies to contributions made on or after January 1 of this year. Based on the state tax rate of 3.07 percent, each $1,000 invested in the college savings plan will reduce the contributor’s tax bill by $31.
The deduction applies to a maximum contribution of $12,000 per contributor, per child. That means a married couple with 529 accounts for each of their three children could contribute a maximum of $72,000 this year (each parent contributing $12,000 for each child), reducing their state tax bill by $2,210. Grandparents and other relatives and friends can also receive the deduction for their contributions to a 529 plan.
The second incentive pertains to the tax treatment of certain withdrawals. Withdrawals of funds invested, as well as earnings on the contributions, are free from federal and Pennsylvania State taxes as long as they are used for qualified education expenses.
Although most states do not tax withdrawals of contributions, Pennsylvania was one of three states that taxed withdrawals from an out-of-state 529 plan. The new law eliminates that tax. Pennsylvania took it one step further by allowing out of state investments to also be deductible. There are only two other states that offer deductions on out of state investments, Maine and Kansas.
You may not be able to contribute the maximum $12,000 per child, but consider investing in a 529 plan now since the new Pennsylvania law allows a deduction of $31 for every $1,000 invested in a 529 plan. •
IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice, if any, contained in this communication (including, unless otherwise provided, any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any matter(s) addressed herein.
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