Is a 529 Plan Right for You?

Why a Dedicated College Savings Vehicle Matters

The cost of education is only going up. It’s a daunting reality for families planning for the future. A 529 plan can be a powerful tool in your arsenal. It allows you to systematically save and invest for those future education expenses while enjoying some compelling tax benefits.

What is a 529 Plan? A Simple Explanation

Think of a 529 plan as an investment account, but with a specific purpose: education. You contribute money, invest those funds, and let them grow over time. The real magic happens when you withdraw the money. As long as it’s used for qualified education expenses, those withdrawals are tax-free. Plus, the 529 plan is becoming more flexible all the time, with new features being added regularly.

Qualified Education Expenses: What’s Covered?

What exactly counts as a “qualified education expense?” The list is broader than you might think. Of course, it includes tuition and fees. But it also covers things like books, supplies, and even equipment. Some plans even allow you to use the funds for K-12 tuition or apprenticeship programs. The definition of what qualifies seems to be expanding every year.

Why Politicians Like 529 Plans

Why are politicians so keen on 529 plans? Because they incentivize saving for education! It’s a win-win. Expect to see continued efforts to make these plans even more appealing.

Unlocking the Tax Benefits of 529 Plans

The State Tax Benefit Landscape: A Patchwork of Rules

The tax benefits of a 529 plan can vary dramatically depending on where you live. It’s not a one-size-fits-all situation.

For example, if you live in Florida, which has no state income tax, you won’t get a state income tax benefit from using a 529 plan. On the other hand, Pennsylvania allows you to use any state’s 529 plan and still get a tax benefit on your Pennsylvania state income taxes. Then you have states like California, which offer no state income tax benefit for using a 529 plan.

The key takeaway? Research your state’s specific rules!

State Tax Benefits: Deductions vs. Credits vs. Carry-Forward

State tax benefits come in a few different flavors. You might get a deduction, which reduces your taxable income. Some states offer a credit, which is a direct reduction of your tax liability. And others have carry-forward provisions, allowing you to use the deduction over multiple years.

Again, it all comes down to knowing the rules in your state.

Federal Tax Advantages: The Power of Tax-Deferred Growth

Even if your state doesn’t offer a tax deduction, you still get a significant federal benefit: tax-deferred growth. This means that the money in your 529 plan grows without being taxed each year. You also won’t receive a 1099 form during the year, so you don’t have to pay taxes until you withdraw the funds. And when you do withdraw the money for qualified education expenses, those withdrawals are tax-free at the federal level.

Warning: Don’t Overfund Your 529 Plan

While it’s great to be prepared, be careful not to put too much money into your 529 plan. You don’t want to end up with a large surplus. A good target to shoot for is around 75% of the projected college costs. However, if your child is likely to go to medical school, law school, or pursue an MBA, you might want to save a bit more.

Funding Strategies and Ownership Considerations

How Much Should You Save? The 75% Target

Why aim for 75%? It strikes a good balance. It provides a substantial head start without overcommitting. It also leaves room for potential scholarships or other financial aid. Of course, adjust this target based on your specific circumstances and your child’s likely educational path.

The Advantage of Multiple Children

If you have more than one child, overfunding becomes less of a concern. You can easily transfer funds from one child’s 529 plan to another. You have control over those funds, and you can change the beneficiary as needed.

Who Should Own the Account? Parent or Grandparent?

As a general rule, the parent or grandparent should be the account owner. This gives you maximum control and flexibility. The child or grandchild should be listed as the beneficiary.

Superfunding: The 5-Year Contribution Rule

Have a lump sum to invest? You might consider “superfunding” your 529 plan. This involves making up to five years’ worth of contributions at once, taking advantage of the annual gift tax exclusion.

In 2025, the annual gift tax exclusion is $19,000. That means you can contribute up to $95,000 to a 529 plan in a single year ($19,000 x 5). And if you’re married, you and your spouse can each contribute $95,000, for a total of $190,000!

Superfunding is best done early, as it allows for maximum compounding of your investment.

Dynasty 529 Plans: Building Multi-Generational Wealth

Want to take your 529 plan to the next level? Consider a “dynasty” 529 plan, designed to benefit multiple generations. With this strategy, you aim to grow the plan large enough to fund educational expenses for your children, grandchildren, and even future generations.

Be cautious, though. State tax benefits may not always justify this approach. Make sure you crunch the numbers and consider all the costs.

Investment Options and Fees: Finding the Right Balance

Speaking of costs, pay close attention to the investment options and fees within your 529 plan. Look for low-cost investment options to maximize your returns.

The good news is that the 529 plan landscape has become much more competitive in recent years. Fees have come down, and there are more low-cost options available than ever before.

Still, it’s essential to compare investment fees to the state tax benefits. In some cases, a lower-cost plan might be a better deal, even if it means forgoing a state tax deduction. And remember that some states may not be as modern as others, which could mean less desirable plans and higher fees.

Dealing with Unused Funds: What Are Your Options?

What to Do With Leftover 529 Funds: An Increasingly Common Question

So, your child has graduated, and you have money left in their 529 plan. What do you do? This is a common question! Luckily, you have several options.

Option 1: Roth IRA Rollover

A relatively new rule allows you to roll over unused 529 funds into a Roth IRA. There’s a lifetime limit of $35,000 for this option, and several requirements must be met:

• The beneficiary of the 529 plan must also be the Roth IRA account owner.
• The 529 account must have been open for at least 15 years.
• No contributions can have been made to the 529 plan within the five years prior to the rollover.

If you meet these requirements, you can essentially transfer the funds into a retirement account, providing even more tax advantages. You could even structure the rollover over multiple years, up to the annual Roth IRA contribution limit.

Option 2: Transfer to a Younger Sibling(s)

You can easily transfer the funds to a 529 plan for a younger sibling(s). You simply update the beneficiary of the account. This is a great way to use the money for its intended purpose: education.

Option 3: Save it for Grandchildren

Another option is to change the beneficiary to a grandchild. This allows you to create a multi-generational legacy of educational savings, giving your grandchildren a significant head start in life.

The (Less Common) Option: Transfer to a Cousin

While less common, you can technically transfer the funds to a cousin. It’s not something you see every day, but it’s an option.

The Last Resort: Non-Qualified Withdrawal

As a last resort, you can always take a non-qualified withdrawal. However, keep in mind that this will result in taxes and penalties on the earnings.

Navigating State Rules and Potential Pitfalls

Does it Make Sense to Game the System for a Deduction?

Some people wonder if it’s a good idea to contribute to a state’s 529 plan just to get the tax deduction, then immediately move the money to a different state’s plan with better investment options.

Clawback Provisions: A Critical Consideration

Before you try to “game the system,” be aware of “clawback” provisions. Some states have these rules, which allow them to reclaim the tax benefits you received if you withdraw the money for non-qualified expenses or transfer it to another state’s plan too soon.

Before implementing this strategy, run the numbers to see if it’s worthwhile. With 529 plans becoming more and more competitive, you might find that the tax savings aren’t worth the hassle.

Utah’s 529 Plan: A Popular Choice

Speaking of popular plans, Utah’s 529 plan is often highly rated. It’s known for its low fees, diverse investment options, and user-friendly platform.

Moving to a New State: What Happens to Your 529 Plan?

Are you planning a move to a new state? What happens to your 529 plan?

You Don’t Always Have to Move Your Plan

The good news is that you don’t necessarily have to move your 529 plan when you move to a new state. Just like you can keep your old 401(k) when you change jobs, you can keep your 529 plan.

If you’re concerned about clawback provisions or simply like your current plan, you can leave it where it is and start contributing to your new state’s plan going forward.

Crunching the Numbers: Is it Worth Moving Your Plan?

However, if you’re considering moving your plan, take the time to “crunch the numbers”. Compare the tax benefits of your new state’s plan to the fees and investment options of your old plan. The goal is to make a financial decision, not an emotional one.

Understanding the Difference Between Maryland and Virginia

For example, if you’re moving from Maryland to Virginia, you’ll want to research the specific rules and tax benefits of each state’s 529 plan to make the best decision.

Maximizing Your 529 Plan Benefits

Getting Credit for Your Contributions: Don’t Miss Out!

Here’s a common problem: Many people miss out on state tax benefits simply because they don’t know how to claim them.

The Importance of Communicating with Your Accountant

Unlike some other tax deductions, states don’t automatically send you a tax document for 529 plan contributions. You need to take the initiative and inform your accountant.

The best way to do this is to upload a year-end 529 plan statement to your accountant each year. This will show them how much you contributed and ensure that you get the proper tax deduction or credit. If you’ve missed this in the past, you might want to amend your previous tax returns to claim those benefits.

Tax Documents: When You’ll Receive Them

Keep in mind that you’ll only receive tax documents from your 529 plan when you start taking distributions.

The Bottom Line: Are 529 Plans Worth It?

So, are 529 plans worth it? Absolutely! They’re a fantastic way to save for education, offering tax-deferred growth and the potential for tax-free withdrawals. While the upfront benefits vary by state, the long-term advantages are undeniable.