A few years ago I was working on a client’s tax return and saw that they made contributions into an Alaska Section 529 plan. The client lived in Iowa. Apparently their investment advisor had advised them to open a plan in Alaska, for reasons that I never understood.
In this situation, can a taxpayer claim a deduction in Iowa for contributions made to another state’s 529 plan?
The short answer is no. Let’s explore further.
What is a “529 Plan”?
A 529 plan is a type of savings account for college expenses. These accounts are managed by states. For example, in Iowa there are two account options: College Savings Iowa or Iowa Advisor 529 Plan.
Money put into a 529 plan is not deductible on a person’s federal tax return, but at the state level many states DO allow deductions on the state tax return. Iowa is one of those states.
When the money is withdrawn from the plan, it’s tax-free as long as the money is used to pay college expenses.
Iowa Deduction for 529 Contributions
Iowa allows a deduction for money put into College Savings Iowa or the Iowa Advisor 529 Plan. But what if, as with my client, a taxpayer in Iowa puts money into another state’s 529 plan? The answer is: there’s no deduction in Iowa. Here’s what the instructions to the Iowa Form 1040 say (my emphasis added in bold):
If you or your spouse participate in the College Savings Iowa 529 Plan (Iowa Educational Savings Plan Trust) or the Iowa Advisor 529 Plan, each may deduct an amount contributed not to exceed $3,239 per beneficiary. These are Iowa Section 529 Plans.
You must be the “participant” in the Iowa 529 plan in order to deduct your contributions. If you are not the “participant” in the Iowa 529 plan, you may not deduct your contributions to that plan.
Only contributions to these two Iowa 529 plans qualify for a deduction on the Iowa return; however, a rollover from another state’s 529 plan to one of the Iowa plans qualifies toward the deduction for Iowa income tax.
So if you live in Iowa and want a 529 plan, make sure you get set up in one of the two Iowa plans … not some other state’s plan. In my client’s case, they got out of the Alaska fund and it’s all in Iowa now, but I’m not exactly certain why their investment advisor had them in an Alaska fund to begin with.