Pennsylvania is giving residents two tax incentives to save for college, even if they go out of state to do it.
State considers replacing college savings manager
Legislation signed this month by Gov. Ed Rendell provides a tax deduction for contributions to increasingly popular 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.
Residents in 27 states and the District of Columbia already get tax deductions for investing in the college savings accounts sponsored by their states, said Kevin McMullen of the College Savings Foundation. But Pennsylvania is going one step further, giving deductions to those who invest in 529 plans sponsored by another state, as well as to those who invest in Pennsylvania's Tuition Account Plans, or TAP.
Maine and Kansas are the only two other states that provide deductions for residents who invest outside the state, but residents of those two states won't be able to take the deductions until they file their 2007 tax returns.
"It looks like a pretty wide open and generous incentive," Christopher Chaney, a vice president of Indiana, Pa.-based S&T Wealth Management and manager of its Downtown office, said of Pennsylvania's new break.
The college savings plans are named after the section of federal law that authorized them. Money in 529 accounts grows tax-free, and withdrawals aren't subject to federal taxes as long as the money is used for qualified education expenses. Contributions are not deductible on federal income tax returns.
The College Savings Foundation estimates there was $75.1 billion in 529 accounts at the end of the first quarter, up 38 percent from year-ago levels.
Each state offers at least one 529 plan and many offer more. Pennsylvania's TAP program has two choices: a guaranteed savings plan that allows investors to purchase college tuition credits at today's prices and another one based on mutual funds managed by Delaware Investments and Calvert Group. There is about $1.4 billion in TAP accounts, according to state Treasury Department figures.
While states offer incentives to residents who invest in their plans, many financial advisers recommend out-of-state plans to clients because their lower fees and better-performing funds outweigh any incentives offered by their state-sponsored plan.
Mr. McMullen says the fact that Pennsylvania is offering incentives even to those who go out of states will encourage more people to save for college.
"We really think it gives investors a choice," he said.
The state tax deduction applies to contributions made on or after Jan. 1 of this year. Based on the state income tax rate of 3.07 percent, each $1,000 invested in the college savings plan will reduce the contributor's tax bill by $30.70.
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 to each child), reducing their state tax bill by $2,210.
The second incentive pertains to the tax treatment of certain withdrawals from 529 accounts. Withdrawals of money invested in the accounts, as well as earnings on the contributions, are free from federal taxes as long as they are used for qualified education expenses.
States don't tax withdrawals of contributions used for education. However, Pennsylvania was one of three states that taxed earnings if a state resident invested in an out-of-state 529 plan. The new law eliminates that tax.
That leaves Alabama and Illinois as the only states that tax earnings on out-of-state 529 accounts, Mr. McMullen said.
First Published: July 14, 2006, 4:00 a.m.
