Maryland Parents: Do You Own an Out-Of-State 529 Investment Plan?

Ted Toal, CFP®

What is a 529 plan?

529 plans were created as part of the Small Business Job Protection Act of 1996 to encourage saving for college. Investments into 529 plans grow tax deferred. And, as long as the funds are used for qualified education expenses, distributions are tax free.

Beneficiaries are not limited to schools within their state; they may attend any college nationwide. Many states even offer tax incentives to residents who invest in their 529 plan.  

Individual States Sponsor 529 plans

Individual states choose providers for their 529 plan. Maryland parents have access to an excellent in-state plan. However, many parents have invested in out-of-state 529 plans. My question is, why?

T Rowe Price manages the Maryland 529 Investment plan and Morningstar rated it a Silver Plan in 2016. Morningstar considers Silver rated plans to have reasonable fees, strong investment choices and capable oversight.

529 Plan State Tax Deductions

Many states allow tax deductions for contributing to a 529 plan. Maryland allows up to a $2,500 tax deduction per taxpayer per beneficiary. This tax deduction is only available for investments made into the Maryland 529 plan. Investments into out-of-state plans do not qualify for the deduction.

So, why do you own an out-of-state 529 plan?

Knowing that Morningstar rates Maryland's 529 investment plan Silver and the plan offers a tax deduction for contributions why did your "Financial Advisor" recommend an out-of-state plan?

Usually, it simply comes down to compensation. Specifically, commissions.

You see, the Maryland 529 Investment Plan is directly sold to consumers and does not pay commissions to financial salespeople. Brokers have no incentive to recommend the plan since they receive no compensation.

Of course, brokers justify using out-of-state plans for many reasons. Some common justifications:

Better performance: The out-of-state plan provided better performance over certain time periods. Even if this is the case, past performance does not predict future returns. Investing in a 529 plan based on past performance alone is rarely a smart move.

Lower fees: The ongoing program management fee in the Maryland plan is 0.05% and the fund fees range from 0.35% to 0.69%. These fees are reasonable and most broker sold plans will have higher ongoing fees, not to mention commission payments.

The tax deduction is not valuable: The most common justification. I've even seen figures saying the deduction is only worth $238 for a married couple. This simply assumes:

• Maryland State tax rate only – does not apply the Local Tax Rate

• Contributions for one beneficiary

For clarification, Maryland's 529 Investment Plan allows up to a $2,500 deduction per taxpayer per beneficiary.

For example, take a married couple with two children who can save large amounts for education.

• Spouse #1 opens 529 plans for each child and deposits $2,500 into both accounts ($5,000 total)

• Spouse #2 also opens 529 plans for each child and deposits $2,500 into both accounts ($5,000 total)

• The allowable Maryland State tax deduction is $10,000, which is not insignificant

Of course, there will always be cases where an out-of-state 529 plan is your best choice. However, for many Maryland parents' savings for their children's education, the Maryland 529 Investment Plan is your best solution.

*There is no guarantee Maryland's 529 Investment Plan will hold a Silver rating with Morningstar

*Fee source: www.savingforcollege.com

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