Written by: The Advisory Team
A 529 plan is a tax-advantaged savings plan designed to help families save for future education costs, primarily for higher education expenses such as tuition, room and board, books, and other qualified education costs. Anyone can open a 529 plan. Typically, they are owned by a parent or grandparent for the benefit of a child/grandchild. The assets are invested like any other investment account. Unlike other investment accounts, the parent/grandparent remains the account owner when the beneficiary reaches adulthood.
Key Features:
Tax Benefits: 529’s are funded with after-tax dollars, but those contributions grow tax-deferred, meaning you do not pay taxes on earnings while the money is in the account. When the money is withdrawn for qualified education expenses, it’s tax-free.
If there’s a distribution for non-qualified expenses, the investment growth is taxed as ordinary income and assessed a 10% penalty.
Scholarship implications: The biggest “what if” questions tend to revolve around a child receiving a scholarship. In the event the beneficiary receives a scholarship, non-qualified distributions up to the amount of the tax-free scholarship can be distributed without the 10% penalty, but the investment earnings will be treated as ordinary income.
Flexibility: Each 529 plan has one designated beneficiary. However, the beneficiary can be changed if the original beneficiary doesn’t need the funds for education.
Ownership: Grandparent owned 529 plans are slightly more favorable than parent owned accounts. Parent-owned 529 plan assets are reported on the FAFSA as parent assets, which can reduce aid eligibility by a maximum of 5.64% of the account value. Grandparent-owned 529 plan assets are not reported on the FAFSA, and therefore, cannot reduce financial aid eligibility.
Distributions from either a parent or grandparent-owned 529 are not reported as student income. Prior rules counted 50% of grandparent owned 529 distributions as available funds for college, but that’s no longer the case.
Contributions: Contributions to a 529 plan are considered gifts. Therefore, typically you can contribute up to the gift-tax exclusion limit, $19,000 in 2025, or $38,000 for married couples, to each beneficiary’s account, without needing to report the gift. 529 plans have a special “super funding” provision, permitting contributions of up to five year’s worth of gifts, currently $95,000 ($190,000 if married), but then the person or couple doing the super funding cannot make any contributions over the next four years.
While there is one account owner and one beneficiary per 529 account, anyone can contribute to a 529. The contribution limits apply to each individual making contributions rather than at an account level.
So, if you have a 529 for your child, tell your friends, tell your parents, tell your neighbors. Anyone can contribute!
Eligible expenses: The use of 529 plan assets has expanded from college or university tuition, room and board, and supplies to include eligible trade schools and apprentice programs, up to $10,000 for student loan payments, as well up to $10,000 of tuition expenses for grades K-12. Note, some states have excluded the $10,000 K-12 tuition reimbursement from 529 plans.
Up to $35,000 can be used to fund a Roth IRA: There is a lifetime lift of $35,000 that can be transferred to a Roth IRA from the 529. Rollovers from a 529 to Roth IRAs are limited to the annual Roth IRA contribution limit, currently $7,000 for those under age 50. Additionally, the 529 plan must have been open for the benefit of the beneficiary for more than 15 years. Contributions made in the last five years—and the earnings on those contributions—are not eligible for Roth IRA rollovers. In other words, you cannot fund a 529 plan with the intention of using those dollars to fund a Roth IRA in the next handful of years.
The IRS has not released guidance on how to approach if the beneficiary changed, a common practice from Child 1 to Child 2 or Grandbaby 1. Does that restart the 15-year clock? Nobody knows.
Let’s look at a few examples.
Example 1: Karen opens a 529 plan for her granddaughter, Sharon, when Sharon is born. Karen contributes $4,000/yr for 10 years and the 529 grows to $80,000 by the time Sharon is 18. Sharon starts working instead of going to college. $7,000/year can be transferred from the 529 to a Roth IRA for Sharon, to the extent Sharon has $7,000 of earned income, for the next several years since the 529 is more than 15 years old.
Example 2: Bob opens a 529 for his son, Barry, contributing $15,000, when Barry is a senior in high school. Bob forgets to use the 529 while Barry is in college. The value has grown to $20,000 by the time Barry graduates and Bob would like to use the funds to contribute to Barry’s Roth IRA after Barry starts working. Unfortunately, the 529 assets do not meet the 15 and 5 year rules, so Bob is precluded from using the 529 assets for Roth contributions. Bob is delighted to learn he can use $10,000 toward Barry’s student loans. Bob can also change the beneficiary to Barry’s younger brother, Ben, using the 529 assets to pay for Ben’s technical school.
Example 3: Ann opens a 529 plan for her son, Andrew, and contributes $10,000. Over time, the account grows to $15,000. After high school, Andrew decides not to continue his education, so Ann withdraws the full $15,000 and moves it to a regular investment account.
Because the account includes $5,000 of investment growth, that portion is considered earnings. Withdrawals from a 529 are treated as a mix of contributions and earnings—so in this case, one-third of the money Ann takes out is considered earnings. That means $10,000 of the withdrawal is tax-free, but the remaining $5,000 is taxed as ordinary income and hit with a 10% penalty since it wasn’t used for qualified education expenses.
If Ann had only taken out $5,000 instead of the full amount, about $1,666 of it would be taxable and subject to the penalty, while the rest would be a return of her original contributions.
Now let’s say Andrew does go to college after all and earns a scholarship that covers his full tuition. If Ann then withdraws the $15,000, she’ll still owe income tax on the $5,000 of earnings—but she won’t have to pay the 10% penalty, because the withdrawal matches the amount of the scholarship.
If you’ve made it this far, you can see the rules are somewhat complicated! Please contact us with questions.
