You have a routine. You wake, dress, brush your teeth, and ready yourself for the day ahead. Your routine comes naturally to you. What if there was a way to monetize part of your routine? Thanks to the Minnesota legislature, if you’re a Minnesota resident, there now is a way to do just that.
Most of our clients have children or grandchildren who will someday go to college. Our clients understand the value and power of having a disciplined savings strategy in place for college funding. For nearly every one of these clients, saving for college is natural. Whether it’s making a monthly or annual contribution, it’s part of their routine.
The preferred savings vehicle for college funding is what’s known as a 529 plan. Section 529 was added to the tax code by a 1996 piece of legislation authorizing “qualified tuition programs,” giving state programs both their popular name and tax-deferred status. Funds invested in these programs are not taxed federally when used for “qualified higher education expenses.”The definition of which has been expanded in 2017 to include up to $10,000 in K-12 tuition.
Historically, states have taken different approaches to incentivize 529 savings. Minnesota has traditionally refrained from offering any incentives. By contrast, roughly 33 states offer tax deductions or tax refunds for 529 contributions. In the spring of 2017, Minnesota passed legislation to incentivize contributions to 529 plans. As many of our Minnesota clients are already faithfully saving with these plans, the new incentive program essentially amounts to free money on the table. It is important to know how the program works, which contributions qualify, and how much you can expect to benefit when you continue to contribute to a 529 plan.
The incentive program in Minnesota is split into two parts: a plan “credit” and a plan “subtraction.” The plan credit is a dollar-for-dollar offset of your tax liability. The credit equals 50 percent of qualifying contributions to any (not just Minnesota’s) 529 plan, up to a maximum credit of $500. The nonrefundable credit may be used only to offset your Minnesota (not federal) income tax liability, so you’ll benefit only to the extent of your tax liability. The maximum credit is phased out as income increases with varying thresholds for individuals and married joint filers.
The alternative to the credit is the subtraction, which is akin to an income tax deduction we are all familiar with. You may subtract from taxable income up to $1,500 ($3,000 for married joint filers) of contributions to any state’s section 529 college savings plan or prepaid tuition plan. Unlike the credit, the subtraction option is available without regard to your income as long as you make a qualifying contribution.
It’s important to note that taxpayers who claim the credit cannot also take the subtraction. Assuming that you make a qualifying contribution and you’re eligible to pick between the credit and the subtraction, which should you take? For the same contribution amount, the credit will typically provide a larger tax benefit than the subtraction. The credit reduces tax liability dollar-for-dollar, while the value of a subtraction depends upon your marginal tax rate. For our clients in the credit phase-out range, we will need to compute the tax benefits under both the credit and subtraction to determine which is higher. Typically it will be the credit, but not always.
We wanted to ensure our Minnesota clients are aware of this important change while recognizing we have clients living in other states all across the country. As mentioned, approximately 33 states offer tax deductions or tax refunds for 529 contributions. Our Advisory Team and the CCM Tax Team are working diligently to optimize education funding strategies for our clients, whether related to this new incentive in Minnesota or in the state where you reside. If you have any questions about the new program in Minnesota, existing incentives in your home state, or if you would like to discuss changes in your contributions given the expansion to include K-12 tuition, please reach out to your CCM advisor.