10 Most Common Questions About 529 Savings Plans

A 529 Savings Plan is a tax-advantaged account used to pay for qualified education expenses. Contributions are typically invested in target-date funds, which gradually shift toward a more conservative allocation as the beneficiary nears college age and will need to begin making withdrawals.

You may be considering a 529 for your child, grandchild, or another family member. Here are some of the more common questions we hear from our clients regarding 529 accounts.

1. What are the tax advantages of 529 Savings Plans?

Contributions to 529s are not tax deductible for federal purposes. However, there may be some state tax benefits, depending on your state’s income tax and the 529 Plans available in your state.

Contributions and earnings grow federal and state tax-free, provided withdrawals are used to pay qualified education expenses.

2. What expenses can I pay with a 529?

Qualified education expenses include¹:

• College tuition at an eligible institution
• Room and board (subject to limits set by the college)
• Mandatory fees, plus any required material for classes (such as books or computers)
• Tuition and qualified expenses of apprenticeship programs
• Special needs equipment or services necessary for students with disabilities or special needs to attend college or university
• $10,000 a year for K-12 tuition costs (certain states only)
• A lifetime maximum withdrawal of $10,000 to pay down student loan debt

Generally, we recommend using the 529 to cover higher education expenses. The longer the funds remain invested in the account, the more the beneficiary will benefit from compounding years of tax-deferred growth. If the 529 plan account balance exceeds the estimated amount of college expenses or if those costs will be covered by another means, then we may recommend using the plan to cover K-12 tuition.

Follow this link for a complete list of 529-eligible universities in the U.S. and abroad.

Starting in 2024, if a beneficiary still has excess 529 funds, you can roll over unused 529 assets ― up to a lifetime limit of $35,000 ― into a beneficiary’s Roth IRA, tax-free, without a penalty. However, the following requirements need to be met ²:

• The 529 plan account owner must have owned the account for at least 15 years.
• Contributions made in the last five years before distributions start are ineligible for a tax-free rollover​.
• The rollover cannot exceed the annual Roth contribution limit​ of the beneficiary.
• The beneficiary of the 529 plan must also be the owner of the Roth IRA​.

It’s important to note that IRA contributions generally require sufficient earned income, but the IRS has not yet issued guidance on whether this applies to 529 plan rollovers. It’s best to work with your financial or tax advisor to advise on your personal situation.

3. Which 529 Plan should I use, and is there a benefit to using my state’s plan?

Each state has its own 529 Plan, so the answer varies depending on where you live and the quality of the plan. There are over 30 states, including Oregon, that currently offer a state income tax credit or deduction for 529 Plan contributions. To see a summary of the different state tax benefits, click here.

While most states require using their own plan to receive the tax benefit, there are currently seven states, including Arizona, that provide residents with tax benefits for contributions to any state plan. In most of these states, anyone who contributes to a 529 Plan is eligible for the tax benefit. However, there are six states that limit the tax benefit only to account owners and their spouses.

Some states, such as Washington and California, do not offer residents state tax incentives for 529 contributions, so residents are free to use any state plan of their choosing.

4. What happens if I withdraw funds to pay for non-qualified expenses?

Typically, you would pay income tax and a 10% federal tax penalty on plan earnings.

5. What happens to the 529 Account if the beneficiary gets a scholarship?

529s may be used to pay expenses not covered by the scholarship, such as books and supplies. The plans can also be used for post-graduate education or be transferred to a relative of the beneficiary for higher-education expenses.

If you have leftover funds, you can withdraw up to the amount of the scholarship without penalties, but you will have to pay income on tax the earnings. However, you will not have to pay the additional 10% penalty that’s imposed on a nonqualified withdrawal. Although still subject to income taxes, one strategy is to have the 529 distributions paid to and reported by the student, as they may be in a lower tax bracket. However, this requires changing the ownership of the 529 account, which may have additional tax implications.

6. Do I need to keep records of the 529 withdrawals for my taxes?

We recommend keeping receipts to document proof that the funds were spent on qualified expenses in case of an audit. However, for tax preparation and withdrawals from the 529 Plan, this proof is seldom needed.

To ensure receipts match up easily, we recommend withdrawing funds from the 529 in the same tax year your costs were incurred.

7. Does it matter who is named as the account owner?

The person establishing the account is listed as the owner, receives account statements, and manages the investments. Withdrawals will be reported on the owner’s tax return. However, anyone can make contributions to the account.

Starting in 2024, non-parent owned 529s no longer count negatively against students for FAFSA (Free Application for Federal Student Aid) reporting purposes as they once did. Parent ownership of the account will still impact financial aid calculations under the FAFSA process, which determines a family’s ability to pay for college before receiving any awards. Under FAFSA, parent assets can reduce aid eligibility by a maximum of 5.64% of the account value, while assets owned by nonparent family members (such as grandparents, aunts, uncles, etc.) do not impact the calculation (as of 2024). However, nonparent 529 plans are still considered part of the CSS Profile, which is used by private colleges and universities to award financial aid.

8. Can I change the name of the beneficiary on my 529 Plan?

Yes, most plans allow transfers to a “member of the family.” For instance, if a couple’s oldest child receives a scholarship, they could reassign funds to anyone else related to the child, such as siblings (including a stepbrother or stepsister), parents, grandparents, first cousins, aunts, and uncles.

9. Is there a limit to how much I can contribute to a 529?

Yes, the limit varies by state and can range from $235,000 to $575,000. We typically recommend spreading plan contributions over several years to stay within the annual tax-free gifting limits to avoid filing a gift tax return:

• An individual can currently gift up to $18,000 per year per child
• A married couple can gift up to $36,000 per year per child

Note: 529 Plans do allow a special one-time contribution worth up to five years of annual gifts. This would require filing a gift tax return, but no gift tax would be incurred.

10. What other strategies are available if I am concerned about overfunding a 529 Account?

• • Continue to save and invest within your own taxable account.
  • Consider gifting appreciated securities to the adult children who are attending college or graduate school. If they are in a low tax bracket, they may be able to sell the stock without paying capital gains tax.

   

As with any investment, it is important to consider how a 529 Savings Plan and other education funding strategies fit in with your broader financial and tax planning. If you would like to discuss your options for education funding, your Coldstream team can help you get started.

¹ “529 Qualified Expenses: What Can You Use 529 Money For?” Savingforcollege.com; https://www.savingforcollege.com/article/what-you-can-pay-for-with-a-529-plan

² “How unused 529 assets can help with retirement planning” Fidelity; https://www.fidelity.com/learning-center/personal-finance/529-rollover-to-roth

Disclaimer:  This article has been provided for informational purposes only and should not be considered as investment advice or as a recommendation. This material provides general information only. Coldstream does not provide any specific tax or legal advice; you should consult your tax, legal, or other advisors before implementing any changes to your current financial situation.

To ensure compliance with requirements imposed by the IRS, we inform you that any federal tax advice contained in this communication (including attachments) is not intended or written to be used and cannot be used for (1) avoiding penalties imposed under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any transaction or matter addressed herein unless the communication contains explicit language that it is a tax opinion in compliance with IRS requirements.  Please contact your tax advisor for guidance on your individual situation.