The future cost of higher education is an unsettling reality for my wife and me, as it is with many families. With the rising costs of higher education, more families are taking advantage of 529 plans. As of June 2024, the number of 529 accounts opened nationally has reached over 16.8 million. A 529 plan is a tax-advantaged investment account that allows you to save for a beneficiary’s education. Even though 529 plans were created to encourage savings for future education expenses, there are many tax-advantaged benefits that come with owning and contributing to a plan.
Taxed-Deferred Growth and Tax-Free Withdrawals
One of the primary benefits of a 529 plan is that your investments grow tax-deferred. This means that you won’t pay taxes on any earnings in the account if the funds remain in the plan. As long as the funds are used to cover qualified education expenses, the withdrawals will be tax-free. Qualified education expenses include tuition, fees, books, as well as room and board, and tuition expenses at an elementary or secondary public, private, or religious school up to $10,000 annually.
State Tax Deductions
Many states offer additional tax incentives for 529 plan contributions, making them even more appealing. While the specifics vary by state, the most common benefit is a state income tax deduction or credit for contributions made to a 529 plan. In some states, you can deduct contributions up to a certain amount from your state taxable income, effectively lowering the amount of taxes you owe. However, not all states provide tax incentives, so it’s important to research your state’s specific rules before contributing.
Estate Planning Benefits
A lesser-known benefit of a 529 plan is its potential for reducing your taxable estate. This can be especially helpful for individuals who are looking to reduce the size of their estate and potentially avoid or minimize estate taxes. Individuals may contribute up to the annual exclusion limit of $19,000 (or $38,000 if married filing jointly) per beneficiary without incurring a gift tax in 2025. 529s also allow for accelerated gifting, permitting you to make five years of contributions in a single year—$95,000 for individuals and $190,000 for couples filing jointly in 2025.
529 to Roth IRA Rollover
A new provision, part of the Secure Act 2.0, allows account holders to transfer up to a lifetime limit of $35,000 from a 529 to a Roth IRA for a beneficiary. This allows account holders to roll over unused funds into a Roth IRA without incurring taxes or penalties. There are some limitations when considering this option, so I recommend you work closely with your financial advisor to determine if this option is right for you.
The tax benefits of a 529 plan make it one of the most powerful investment vehicles available for saving for education. With tax-deferred growth, tax-free withdrawals for qualified expenses, potential state tax deductions, and estate planning advantages, it’s clear why so many families rely on 529 plans to fund their education goals. Before you open a 529 plan, it’s important to consult with your financial advisor to ensure you’re choosing the right plan for your needs and making the most of these tax advantages.
Sources:
1. https://www.irs.gov/newsroom/529-plans-questions-and-answers
2. https://www.collegesavings.org/529-plan-data
