Paying for College

One Foolproof Way to Earn More on Your College Savings

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Tax breaks, matching grants, and scholarships can effectively boost your investment by an average of 6%.

Savers in many states don’t have to rely solely on the markets to build up a college fund. Grants or tax benefits can effectively boost the value of your investment in a 529 college savings plan by 10%, 20% or even 30%, according to a newly released analysis by Morningstar.

In the 32 states (plus the District of Columbia) that offer subsidies to college savers who contribute to their home state’s 529 plan, the average benefit is a one-time boost worth about 6%.

In New Jersey, parents who seed a NJ BEST 529 account with $1,200 when their kid is about six and kick in at least $300 a year after that will qualify the student for a one-time $1,500 freshman scholarship to an in-state public university. That’s a return of 31.5% on a total investment of $4,800.

Most states simply give parents a tax credit or deduction for a 529 contribution, which translate into a lower state tax bill and thus more money in your checking account. That’s money you can use for anything—including adding to your 529 or offseting the cost of saving for any college.

Residents of Indiana, for example, qualify for a state tax credit worth up to 20% of what they invest in the state’s 529 plan, which can reduce a typical family’s state tax bill by $480. Vermonters get tax breaks typically worth 10% of their investments in their local 529 plan.

Five states offer tax breaks for an investment in any 529, allowing residents to shop for the best plan anywhere. Two of those five states reward both choices: Maine offers a 1.7% tax benefit for any 529 investment, but also provides matching grants for saving in the state’s 529. Pennsylvania’s has tax breaks worth about 3% for any college savings, but it also offers scholarships to hundreds of mostly private colleges across the country for those who invest in-state.

Fifteen states either have no income tax or don’t offer any subsidy to college savers. Check out this 50-state map to see whether to invest in your state, or out of state.

Beware of the Gotchas

The author of the Morningstar report, Kathryn Spica, says you should watch for two big potholes when trying to maximize these freebies.

1. High fees: Some states charge such high fees in their 529 plans that any parent with a child younger than, say, 13 should probably forgo the tax benefit and choose a low-cost, highly-rated direct-sold plan. But for parents of teens close to college, the immediate tax benefits can outweigh only a few years of higher fees.

For example, D.C. offers tax breaks that amount to a one-time 8.5% effective boost to your college savings. But D.C.’s plan charges a high annual fee of 1.35% of assets. Utah’s plan, which gets the highest rating by Morningstar, charges only 0.2%. Within eight years, D.C.’s higher fees would likely eat up your tax benefit.

2. Changing rules: North Carolina cancelled its tax break for 529 savings last year. And Rhode Island has stopped enrolling new parents in its savings match program, Spica says. Parents in states that end or slash tax benefits should take a few minutes to run the numbers and see which investment option best meets their needs.

The Value of the Tax Breaks

The chart below lists the states that offer benefits for investing in the home state 529 as of fall 2014. Morningstar’s estimated value of the subsidy is based on a family earning $50,000 a year and saving $2,400 a year for college. The fees are those charged for an age-based fund for a 7- to 12-year-old that employs a moderate (as opposed to conservative or aggressive) investment strategy.

The final column is Money’s recommendation on whether parents of kids younger than 13 should stick with their state’s best 529 option, or risk giving up the state’s benefit and shop for the best plan nationally.

If your state is not listed here, you won’t be giving up anything if you simply pick the best plan available. Here are Money’s recommendations for the best 529s nationally, based on a combination of the fund’s fees, the state’s tax benefits, and the ratings given the plans by Morningstar and Savingforcollege.com.

State Est. value of state tax benefit on savings of $2,400 a year Effective yield on $2,400 investment Average fee for moderate equity plan for 7- to 12-year-old Should parents of kids under the age of 13 invest in-state or shop?
Indiana $480 20% 0.57% In-state
Vermont $240 10% 0.45% In-state
Oregon $216 9.0% 0.38% In-state
District of Columbia $204 8.5% 1.35% Shop
Idaho $178 7.4% 0.75% In-state
Arkansas $168 7.0% 0.60% In-state
South Carolina $168 7.0% 0.12% In-state
Montana $166 6.9% 0.88% Shop
Iowa $156 6.5% 0.26% In-state
New York $155 6.5% 0.17% In-state
Wisconsin $150 6.3% 0.23% In-state
Georgia $144 6.0% 0.33% In-state
West Virginia $144 6.0% 0.32% In-state
Maine $140 5.8% 0.30% In-state
Virginia $138 5.8% 0.61% In-state
Oklahoma $126 5.3% 0.51% In-state
Alabama $120 5.0% 0.32% In-state
Connecticut $120 5.0% 0.40% In-state
Illinois $120 5.0% 0.19% In-state
Mississippi $120 5.0% 0.65% Shop
Nebraska $120 5.0% 0.48% In-state
Utah $120 5.0% 0.22% In-state
New Mexico $118 4.9% 0.36% In-state
Maryland $114 4.8% 0.88% In-state
Colorado $111 4.6% 0.39% In-state
Michigan $102 4.3% 0.28% In-state
Louisiana $96 4.0% NA In-state
Ohio $90 3.8% 0.23% In-state
North Dakota $68 2.8% 0.85% Shop
Rhode Island $38 1.6% 0.20% In-state
Pennsylvania Variable N.A. 0.38% In-state
New Jersey Up to $1,500 N.A. 0.77% In-state can pay if student definitely will attend a participating college
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