Exploiting the Colorado 529 Tax-Deduction Loophole

Colorado’s state-sponsored college savings plans are especially taxpayer-friendly.  The various 529 plans allow for a full Colorado state income tax deduction for contributions made to the plan by state residents, and funds withdrawn for qualified higher education expenses will be free of federal and state income taxes for any investment gains.


While 529 plans can be an excellent long-term savings vehicle, the Colorado plans also offer a great perk to parents and students who are about to pay or are already paying tuition and fees. Because there is no minimum time period for funds to be invested in the 529 plan, tuition payments can be made as follows:

1) A contribution for the full tuition payment (up to the maximum 529 plan contribution allowed by law) is first made to the 529 plan account,

2) A withdrawal request is made to have the tuition payment sent from the 529 plan account directly to the educational institution

3) The person(s) making the tuition payment via the 529 plan now receive a full Colorado state income tax deduction for the tuition payment

This method essentially nets a 4.63% (Colorado’s state income tax rate) return by the tax savings offered.  Given the short period the funds may be in the 529 plan, tuition payers should be sure that the 529 plan account is commission-free, as the cost of a sales commission could offset some or all of the tax benefits.  In Colorado, the “Direct Portfolio” 529 plan offered through CollegeInvest is the commission-free plan, and the “Scholar’s Choice” plan is sold through brokers and carries sales commissions.

Gifts to a child’s 529 plan are subject to annual federal gift limits, $14,000 for 2013 and 2014. 529 plan donors can front-load five years of gifts at one time, for a per-person total contribution of $70,000.  Colorado 529 plans are subject to a maximum account balance of $350,000 beyond which no further contributions are allowed.  Of course, consulting your tax advisor and financial planner that this method works for you is always highly recommended.

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