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The Section 529 plan: A versatile financial planning tool

Financial Planning

You’re probably aware that the Section 529 plan is one of the most effective college savings vehicles available. But did you know that its benefits extend well beyond financing higher education costs? 

For example, you can use these plans to fund limited amounts of elementary and secondary school expenses. Plus, they offer some unique estate planning benefits. And now, under the SECURE 2.0 Act, if your plan is overfunded, you’re allowed to roll over some or all unused funds into a Roth IRA.

How do they work?

529 plans are tax-advantaged investment accounts, sponsored by states or state agencies and designed to help families save for education expenses. Although lifetime contribution limits vary from state to state, they can reach as high as $500,000 or more per beneficiary.

Cash contributions to 529 plans are nondeductible for federal tax purposes, but the funds grow on a tax-deferred basis and withdrawals are tax-free so long as they’re used for “qualified higher education expenses.” Qualified expenses include:

  • College or vocational school tuition, 
  • Fees, room and board, 
  • Books and equipment and
  • Up to $10,000 per year in elementary or secondary school tuition.

If you use 529 plan funds to pay for nonqualified expenses, the earnings portion of the withdrawal is subject to income tax plus a 10% penalty.

There may also be state tax benefits to investing in a 529 plan. Many states offer tax deductions or credits for contributions to plans they sponsor. And 529 plans provide financial aid advantages because they’re considered an asset of the parents rather than of the student.

Options for unsused plan funds

If you save too much and end up with unused funds in a 529 plan, you have several options:

Withdraw the funds. You’ll have to pay taxes and any penalties, but you can use the money for whatever you want. Note: If your child receives a scholarship, you can withdraw that amount subject 
to taxes, but not penalties.

Designate a new beneficiary. This can be another one of your children, a relative outside your immediate family, or even you or your spouse. Remember, 529 plans aren’t just for kids. You can also use them for continuing education or for certain trade 
school programs. 

Hold on to the plan. You may be able to use it for a grandchild who hasn’t yet been born.

Pay off student loans. You can also withdraw 529 funds tax- and penalty-free to pay down student loan debt, up to a lifetime maximum of $10,000 per beneficiary.

What are the estate planning benefits?

Although 529 plans are primarily education savings accounts, they also offer some surprising estate planning benefits. Traditional estate planning vehicles, such as irrevocable trusts, require you to relinquish most control over the assets they hold to insulate them from estate tax. Contributions to 529 plans, like trusts, are considered completed gifts, so they’re removed from your taxable estate. Unlike trusts, however,  you maintain a great deal of control over the funds. For instance, you can direct the timing and amount of distributions, change  the beneficiary, transfer the funds to another 529 plan, or even close the account and get your money back (subject to taxes and penalties).

Although 529 plan contributions are subject to federal gift tax, they qualify for the annual gift tax exclusion of $18,000 per recipient ($36,000 for gifts split with a spouse). But unlike other vehicles, they can be front-loaded with up to five years of annual exclusions. So you can contribute as much as $85,000 ($170,000 for married couples) to a 529 account in  one year without triggering gift taxes or using any of your lifetime gift and estate tax exemption. This is particularly valuable now, because the exemption — currently $13.61 million — is scheduled to be cut in half in 2026.

What if you save too much?

Given the high cost of a college education, it’s common for parents to open a 529 plan soon after their children are born. But what if your savings end up being more than you need? Perhaps your child decides not to go to college or receives a scholarship that covers most or all of his or her college costs. If this happens, you don’t necessarily have to close the account and pay taxes and penalties. (See “Options for unused plan funds” above.)

Thanks to the SECURE 2.0 Act, you now have another alternative: You can roll over some 529 plan funds into a Roth IRA for your child, tax- and penalty-free, jump-starting your child’s retirement savings. But these rollovers are subject to several requirements:

  1. Total rollovers can’t exceed $35,000 per beneficiary.
  2. The 529 plan must have been opened at least 15 years before the rollover is made.
  3. Rollovers can’t include contributions made within the preceding five years (or earnings on those contributions).
  4. The rollover must be executed through a direct trustee-to-trustee transfer.

Note: Even if these requirements are met, rollovers are subject to the usual annual limits on Roth IRA contributions — currently, the lesser of $7,000 ($8,000 if over age 50) or the beneficiary’s earned income.

All-Purpose Financial Tool

If college costs are in your future, a 529 plan is a great way to save. And if it turns out you don’t need the funds for higher education expenses, these plans are flexible enough to adapt to changing circumstances and serve other financial functions.