If you are enjoying the advantages of the federal tax benefits that accrue when you use 529 savings plan to fund your children’s college plans, take note. You may end up paying more in state taxes next year. Alabama, Arkansas and Pennsylvania are among the states that already levy tax on out-of-state withdrawals. And, four more states recently announced plans to jump on the taxation band wagon.

State-run college savings plans—dubbed 529 College Savings Plans after the section of the tax code that governs them—are a great way for parents to save for their kids’ future college costs. As long as the plan satisfies a few simple requirements, the federal tax law provides special tax benefits to plan participants. Every state has some autonomy in structuring the 529 plan, or plans, it offers and currently every state has at least one plan.

However, in recent months, in an effort to address budget shortfalls, some states are taking a bite out of the 529 tax savings by taxing residents who invest in out-of-state plans. Don’t panic—as yet, only a handful of states have targeted out-of-state 529 plans. Whether this turns into a nationwide trend remains to be seen, but it in the meantime, it makes good sense to stay informed. Our office will be happy to provide you with the latest news on relevant changes in state tax levies.

More recently, the following states announced their own plans to tax out-of-state 529 plans:

• Maine and Illinois will tax withdrawals from out-of-state plans as income. (Currently Maine’s assessment is set to expire after 2005);
  


• Tennessee plans to levy taxes on dividends and interest; and
  


• New York State residents who roll over New York State 529 assets into an out-of-state program will be hit with capital gains taxes on any earnings.

If you do reside in one of the states that have hooked onto the out-of-state plans, think through all the implications before making any major changes in your approach to college savings. Remember that the state tax bite may be relatively small and should be weighed alongside plan performance and other important considerations.

We will be monitoring new developments regarding 529 plans. If you would like more information on this issue, or need help evaluating the tax implications of various college savings options, please call our office. We would be glad to help guide you.