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Can I use an in-state 529 to pay for an out-of-state school?

March 22, 2012: 6:00 AM ET

I want to open a 529 for my kids. We currently live in California, but what happens if they choose to go to a school out of state? From what I understand, we may lose some state tax benefits, but they will still be able to use the funds. Is that right? —- Name withheld

For California residents, qualified distributions from a 529 plan are exempt from federal and state income tax, no matter where your children end up going to school. In fact, you don't even have to use California's 529 plan for your kids. While some states offer a state tax deduction to residents for sticking with their home state's 529 college savings plan, California does not. So there's no reason not to consider other states' plans.

"My favorite plan to recommend to California residents is the Utah plan with age-based Vanguard investment options," says Patrick Stark, a financial planner in Newport Beach, Calif. "It has rock bottom fees, the diversification of investments is excellent, and the allocation becomes more conservative as the child grows older." There is no tax disadvantage to using another state's plan, no matter where your kids go to school. Save away.

-- Kate Ashford

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