529 Plans – Taxes, Estate Planning, and Funding College

by | Sep 7, 2021 | Estate & Legacy Planning, Financial Planning, Insights

Paying for college isn’t cheap and it’s not getting cheaper. Whether you’re planning for kids or grandkids, you’re staring down an average of $21,950 per year for an in-state public college or $49,870 per year for a private university.

For most families, meeting college expenses combines multiples sources: savings, scholarships, grants, loans, or gifts from a generous family member. But you certainly don’t want to leave college funding to chance. A 529 plan is a great first step toward making sure your children or grandchildren can achieve their educational aspirations.

Why a 529 plan?

A 529 plan is a college savings accounts with several advantages:

  • Funds can be used for qualified expenses like tuition, books, supplies, room and board at an accredited college.
  • Up to $10,000 per beneficiary per year can be used for elementary or high school expenses.
  • When funds are used for qualified expenses, you’ll pay no federal income or capital gain tax on investment gains.
  • Accounts are usually opened by a parent or grandparent and names a child or other family member as a beneficiary. Beneficiaries can be changed to any other qualified family member.
  • You can use up to 5 years of federal gifting, $90,000 ($18,000 per year) in 2024, in a single year per beneficiary. Actual contribution limits are set by each 529 plan and can be as high as $300,000 or more.
  • Unlike alternative strategies like Coverdell IRAs and UGMA/UTMAs, 529s have no age or income limit on contributions or distributions.


How much should I save into a 529 plan?

While the limits are quite high, your recommended savings amount depends on exactly what you want for your child, grandchild, or loved one. Consider the following questions:

  • What do you want to provide? A fixed amount per year? Tuition for in-state college? Full ride anywhere in the country? This helps determine your total savings target. Your financial advising team can help forecast total cost based on answers to these questions.
  • Is tax-free growth or flexibility more important to you? This helps determine how much of your total savings target should be inside a 529 plan and how much should be funded from other investments. We commonly see clients fund a portion of expected costs through a 529 and the rest in other investments that aren’t penalized if used for other purposes.


What if I don’t use the full 529 amount for education?

If your 529 beneficiary doesn’t use the funds for education, all is not lost. You still have options.

  • Withdraw the money. You’ll pay a 10% penalty and ordinary income tax on earnings withdrawn for anything other than qualified education expenses, but the money is yours. If your beneficiary qualifies for scholarships, you’ll still pay income tax, but won’t be charged the 10% penalty on the amount equal to the scholarship.
  • Choose another beneficiary. If set up for your child but unused, consider holding the 529 for grandkids, nieces, nephews, or other family members. They will still benefit from the tax-free withdrawals for education.
  • Convert to Roth for the beneficiary. The SECURE Act 2.0 added an opportunity to convert some unused 529 funds to a Roth IRA for the beneficiary. See 529s, SECURE Act 2.0, and a New Backdoor Roth IRA Opportunity for more.


Do 529 plans affect financial aid?

When applying for federal aid, parents and students are required to disclose financial information like income and assets to determine expected family contribution (EFC) and aid eligibility. The higher your EFC, the less need-based aid (Pell Grants, subsidized loans, work-study programs) you’re likely to qualify for. However, not all assets are counted equally.

  • 20% of a student’s assets, including UGMA/UTMA accounts, are counted toward EFC.
  • 5.64% of a parent’s assets count toward EFC.

Because 529 assets are considered as assets of a parent, they will affect financial aid eligibility far less than other strategies.

The new simplified FAFSA, expected to start for the 2024-2025 school year, will also make grandparent-owned 529s much more effective. Currently, distributions from a 529 owned by someone other than a parent or student, like a grandparent, count toward a student’s income, which can significantly reduce aid eligibility. For grandparents, it can make sense to transfer ownership of a 529 for your grandchild to the parent under the current rules. However, the new FAFSA will no longer require students to report cash support from grandparents as income, including distributions from grandparent-owned 529s. Discuss your situation with your financial advising team to determine the best course of action.


Can 529s help me avoid estate taxes?

Estate planning is a tug of war between taxes and control. You can make irrevocable gifts to beneficiaries or trusts to reduce the value of your taxable estate, but you’ve now lost control of those assets. Or you can keep control of the assets and accept that they will be included in your taxable estate. In some cases, you can move assets out of your estate, without putting them entirely out of reach.

529s can bridge this gap. Contributions are considered an irrevocable gift for estate planning purposes, so these accounts grow outside your estate. However, you retain ownership and can cash in the account anytime, subject to the above penalties.

With the 2024 annual gift limit set at $18,000 and the ability to use up to five years at once, a married couple could contribute up to $180,000 per beneficiary to a 529.

Your financial advising team will be able to determine if and how a 529 plan fits for you. For the right situation, 529 plans can help reduce taxes and fund education for future generations of your family!

Investing in 529 college savings plans generally involve investing in mutual funds. Most mutual fund companies offer different share classes. Although each share class represents a similar interest in the mutual fund’s portfolio, the mutual fund company will charge you different fees and expenses depending upon your choice of share class. Breakpoint discounts may be available through various means, such as Rights of Accumulation or a Letter of Intent. Direct plans offer the client the ability to go directly to the sponsor to open up their accounts. These tend to have lower fees, but are considered do-it-yourself type plans without the benefit of a Financial Professional. RESIDENT STATE ADVANTAGES Your resident state may be a sponsor of a 529 Plan with certain tax and other advantages that must be weighed before making a decision as to which state’s plan to invest in. Consult your Financial Professional or your state’s website for more information.

Josh Whelan

Partner, Financial Advisor

About the Author

Josh sees his profession as a calling, not just a career. His motive for pursing financial planning was very personal. While working on a degree in marriage and family counseling, Josh’s father was diagnosed with multiple sclerosis. Josh decided then and there to change career paths to help his family prepare for an uncertain financial future. Financial planning became his path to serving others.

The “Alterra” name was coined by joining the Latin roots “alter”, the origin of the word “altruism” with “terra” meaning earth or land. This name reflects the company philosophy of “clients before profits” and providing firmly grounded advice.

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