Paying For College Out of Pocket? Read This.

February 29, 2016

The following is not advice. It is information about an option you have as a Colorado resident who is considering or attending post-secondary school and looking to save money.

Last year I opened 529 plans for my two nieces and nephew in lieu of birthday and Christmas presents. Over the course of the year I have been contributing to their plans, and recently thought about opening one for myself. If I were to pursue a graduate degree or take classes at the local community college, it would be nice to have money earmarked for education.

Not everyone had family members with the foresight and/or means to open a 529 when they were children. Fortunately, 529 plans have no age restrictions and you can open one for yourself. Nothing is preventing you from opening one now and taking advantage of at least one of its benefits—tax benefits, to be specific.

If I lost you, allow me to elaborate. A 529 plan allows individuals to set aside money for college—usually for a child. Similar to a 401(k), regular contributions are invested in hopes the account will grow and compound. When a beneficiary is ready for college, ideally the account will be worth more than the amount contributed. With a well-funded 529, a student would be able to leave college with no or minimal student loans.

There are 48 states and the District of Columbia that sponsor 529 plans. Many can appear to be shades of the same color, however, they can be very different. Past performance, fees and investment options help the purchaser sift out the best contenders from the middle-of-the-road plans and the ones to be avoided. Most states allow non-residents to enroll in their plan(s), but there may be perks to using your state’s 529. In Colorado, you have three state-sponsored 529 plans to choose from, which are offered by CollegeInvest.

Historically, states like when its residents spend their hard-earned money in-state. To encourage this behavior, many states offer residents a tax break if a contribution is made to their state’s 529 plan(s). The tax break is usually not on the entire contribution though. The majority of states have a cap on how much of an annual contribution is tax deductible. For example, contributions to an Alabama 529 plan of up to $5,000 per year by an individual, and up to $10,000 per year by married taxpayers filing jointly who each make their own contributions, are deductible. Anything above their cap would not be tax-deductible. Not so in Colorado.

As a Colorado resident, you are allowed to deduct all of your contributions up to your taxable income. In other words, if your taxable income is $40,000, you could theoretically contribute $40,000 to the 529 and receive a tax break on the entire amount. Only three other states offer anything similar: New Mexico, West Virginia, and South Carolina.

Another component of many 529 plans is a ‘holding period’. This mandatory waiting period is the amount of time the contribution has to sit in the 529 before it is withdrawn. Michigan and Illinois both have a 12-month holding period, for example. It is likely that there are several reasons for 529 plans to implement holding periods, one of which is to encourage parents to begin contributing early on in their child’s life.

What’s Colorado’s holding period? Seven days.

What do these two features allow Coloradoans to do? Make a contribution to the state-sponsored 529 and a week later pay their tuition bill with tax-free money.

Imagine this: It’s December and you have registered for classes that start in January. You open a 529 plan and contribute the tuition for the two classes you will be taking, plus money for materials, before the end of the year.

The second week of January you transfer the money you need from the 529 to your checking account to pay your tuition bill and purchase your materials. The distribution will be tax-free because it is being used for educational purposes.

When you file your state tax return in the spring, you will notice that the contribution you made in December to your 529 decreases your taxable income dollar-for-dollar. This would save you 4.63 percent (the Colorado state income tax rate).

It is the same percentage everyone pays regardless of income. You would save that percent of every dollar you put into the Colorado 529 plan and then used for college.

This opportunity is not limited to the month of December. You can do this anytime of the year. The drawback is that you will have to wait longer to use the tax deduction. I like the December/January arrangement because I can use the tax deduction sooner.

Let’s look at an example:

Michael is taking two classes and purchasing textbooks for his occupational therapy program.

college costs



By funneling the money through his 529 plan first, Michael will save himself $116.30 in Colorado income tax.

That could buy a dinner for two at a high-end restaurant. Or be used as an extra student loan payment.

This is only one of the strategies you can use to reduce your tax liability if you are in school. As we previously wrote in the Dime, individuals who are enrolled in their first four years of college may be eligible to claim the American Opportunity Tax Credit. Those who are in graduate school may be eligible for the Lifetime Learning Credit. Either of those may be more valuable than using this tax deduction tactic, depending on your situation. Be sure to investigate your options.

We all have a financial toolbox at our disposal that can help us manage our money. One of the tools you have available in that is a 529 plan. Speak with a tax professional or financial planner to determine the best plan for you.