Your Complete Guide to 529 Plans and Tax Savings

529 Plans and Tax Savings

Your Complete Guide to 529 Plans and Tax Savings

Planning for your child’s education is an integral part of financial well-being. As the price of higher education isn’t cheap, it’s a good idea to start saving earlier rather than later. A 529 plan provides tax-free investment growth and funds for qualified education expenses. To help you start, we’ve created a comprehensive guide to utilizing these plans, rollover options, front-loading strategies, leftover fund alternatives and trade school programs. 

Introduction to 529 Plans

Formally known as qualified tuition programs, 529 plans are tax-advantaged savings plans used for education costs. Two types of plans are available: prepaid tuition plans and education savings plans.

Prepaid Tuition Plans

Prepaid tuition plans allow an account holder, typically parents or grandparents, to purchase credits at current prices from participating colleges and universities (usually public and in-state) for a beneficiary to use for future tuition and fees. 

Typically, these plans can’t be used for room and board or books and supplies and don’t allow the account holder to prepay for tuition at private elementary and secondary schools. Most have residency requirements for the account holder and beneficiary. Overall, these plans let you prepay all or part of the tuition costs of an in-state public college education and may also be converted for use at participating private and out-of-state colleges.

Education Savings Plan

This plan works much like a Roth 401(k) or Roth IRA by investing your after-tax contributions in mutual funds or similar investments. This plan allows an account holder to open an investment account for a beneficiary’s future qualified higher education expenses, including tuition, fees and room and board. These funds can be used at any college or university, at some non-U.S. colleges and universities and at select apprenticeship programs. One significant difference of the education savings plan is it allows $10,000 per beneficiary for tuition at any public, private or religious elementary or secondary school.

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529 Rollover Options

The IRS allows one tax-free 529 plan rollover per beneficiary in a 12 months period. Two rollover methods exist. The first is a direct rollover, where the 529 account transfers directly from one financial institution to another. 

The second method is an indirect rollover, where the account owner takes a distribution and then deposits the funds in the new 529 plan. These funds must be deposited into the new plan within 60 days. The deposited amount must indicate the contribution is a rollover and must provide a breakdown of contributions and earnings. If a breakdown is not included, the entire rollover amount is assumed to be earnings and you could be liable for taxes and a 10% penalty. 

Most states offer a state income tax benefit for residents who contribute to a 529 plan. Eighteen states allow a portion of a rollover amount to be eligible for state income tax benefits.

Limits exist for the amount of annual 529 contributions eligible for the state income tax benefit. If you live in one of these states, a strategy could be to roll over the maximum qualified amount and leave the rest in the old plan. This strategy can also provide diversification benefits as each state’s 529 plan has different investment options based on levels of risk and centered on the child’s age.

One key consideration is whether or not you claimed a state tax deduction or credit for your 529 contributions in a prior year. Check the recapture tax rules for your state — some states treat rollover proceeds as a nonqualified distribution. In this case, the outbound rollover might be subject to the recapture of prior state tax benefits on top of incurring state withdrawal penalties.

Can I Have Multiple Children Listed With One 529 Plan?

Because each plan has only one beneficiary, you must change the beneficiary to take qualified distributions for another child. Instead, you could use the indirect rollover method to create another sibling’s 529 plan as you move to a new state. This can save time by not continually switching the beneficiary to take qualified distributions and providing a tax benefit on state income taxes. It’s also easier to customize each sibling’s portfolio risk based on their age.

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529 Plans and Tax Savings

Front-Loading a Qualified Tuition Plan

Front-loading a qualified tuition plan can work for someone who either has the financial resources now, or will be receiving a large inheritance and/or a big bonus in the future. Sometimes a family member will want to fund a child’s higher education. Knowing the option of front-loading your 529 plan can be a supercharged saving strategy. 

In 2023, the gift tax rule allows an individual to annually gift up to $17,000 without filing a gift tax return with the IRS. Yet, with front-loading, the IRS offers a special rule allowing individuals to contribute up to five years’ worth of the annual gift limit of $85,000 in 2023. Instead of contributing $17,000 per year per child, you could contribute $85,000 in the first year and $0 in years two through five. The $85,000 wouldn’t be taxable. For a married couple, this amount could double to $34,000 per year per child or $170,000 in combined front-loading total.

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What to Do With Leftover 529 Funds

Some families who are financially able to fully fund a 529 later discover their gifted or athletic child earns a full-ride scholarship, decides to join the military or receives unexpected gifts or inheritances from relatives. 

When this situation happens, one of the most common choices is changing the 529 plan’s beneficiary to another qualifying family member without tax consequences. This decision makes sense for families who have one or more additional children planning to attend college or for donors who want to help pay for a niece or nephew’s private K-12 education. 

One caveat of using leftover 529 funds is to avoid skipping a generation if you change the beneficiary. This could trigger a tax penalty based on the Generation-Skipping Transfer (GST) tax, known as GST. This tax is applied to contributions if the beneficiary to whom the funds are transferred is at least two generations or 37 and a half years younger than the donor. However, most families are shielded due to the annual GST exclusion of $17,000 per individual and $34,000 for a couple. 

Another option is for the parents to make themselves the beneficiary and use the funds to continue their education if they desire. If your child decides not to pursue a four-year degree, it doesn’t mean they won’t need the funds later. You may consider keeping funds in a leftover 529 if your child decides to attend college later, continues a graduate or professional program or pursues a different field of study.

Recent changes to the law allow money to be used for student loan payments. The Secure 2.0 Act 2.0 allows families to take tax-free 529 distributions to pay off student loans. Both principal and interest payments toward a student loan are considered qualified expenses. You can withdraw up to a $10,000 lifetime limit in qualified student loan repayments per 529 plan beneficiary and their siblings.

Since there is no time limit on spending 529 funds, there’s an opportunity to leave unused money as an educational legacy to grandchildren. You may even consider using a 529 plan as an estate planning tool. The value of your 529 is excluded from your taxable estate if you retain control of the account. 

Additionally, you can take a non-qualified withdrawal without paying the penalty on earnings if the beneficiary dies, joins the military or receives a scholarship, which is limited to the amount of the scholarship. You will have to pay income tax on any gains in the account. Lastly, you can take a non-qualified distribution. Your contributions will never be taxed or penalized, but any earnings above your contributions will be subject to income tax and possibly a 10% penalty.

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Using 529 Funds for Trade Schools

With a skilled labor shortage in the United States, trade schools and similar programs can be an attractive alternative to a traditional four-year degree. There are currently more than 7,000 trade schools designed to prepare students in less than two years for their desired field of study. 

According to a Value Colleges report, the average total cost to complete a trade school program is $33,000. This is less than the $35,830 current cost of a single year of tuition and fees at a private nonprofit four-year college. 

Students can use a 529 plan to pay for these accredited programs. Qualified higher education expenses at a trade school are the same as at a traditional four-year college, including tuition, textbooks, supplies, computers and room and board expenses. If parents originally set up a 529 plan to save for a child’s four-year college degree, they may still withdraw funds tax-free to pay for trade school expenses. 

Learning a skilled trade instead of a four-year degree offers many benefits, including lower tuition costs and median wages averaging $60,000 to $90,000 per year or more, depending on the industry. Some trade schools may also offer on-the-job training to prepare students with real-world experience before graduation. If your child’s goal is to become an avionics technician, boilermaker, dental hygienist, elevator technician or any other skilled labor career, there is a program and financial plan for them. 

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Work with a Fortune Financial Advisor

We have successfully worked with individuals and households to turn their dreams and ambitions into financial reality since 2008. We can help you use the tax-advantaged 529 plan to save for future education expenses. Contact an advisor at Fortune Financial with questions related to college funds or other financial issues at You can also scan the QR code below to connect with us.

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Important Note

This material is provided for educational purposes only and does not constitute investment advice. The information contained herein is based on current tax laws, which may change in the future. Fortune Financial Advisors cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. The information provided in these materials does not constitute any legal, tax or accounting advice. Please consult with a qualified professional for this type of advice. The information provided above is obtained from publicly available sources and is reliable. However, no representation or warranty is made as to its accuracy or completeness.