All About 529 Plans

This three-part series on 529 plans was adapted from an article by Lawrence Pon, CPA/PFS.

Part I: The 529 Primer

What is a 529 plan?

A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.

The most common type of 529 plans are education savings plans, which let savers open an investment account to save for the beneficiary’s future higher education expenses. Withdrawals from education savings plan accounts can generally be used at any college or university in the U.S.

It is important to understand the fees and expenses associated with 529 plans, which can include enrollment or application fees, annual account maintenance fees, ongoing program management fees, and ongoing asset management fees. Additionally, investing in a 529 plan will generally impact a student’s eligibility to receive need-based financial aid for college. Before investing, consider consulting a tax adviser to make sure you understand the full financial implications this will have for your family.

Fun 529 facts

There is no federal deduction for contributions to a 529 plan.

In some states, there is a state income tax deduction for contributions to the 529 plan. Please check your applicable state rules.

Withdrawals from a 529 plan are tax-free if used to pay for eligible education expenses. These expenses include tuition, fees, books, supplies, and equipment. The equipment generally includes a computer, software, and internet access.

Room and board are an eligible expense if the student is enrolled at least half-time. For students living and eating off campus, 529 plans can be used for rent and grocery bills. The limit for room and board expenses is the greater of:

the allowance for room and board, as determined by the school, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student, and
the actual amount charged if the student is residing in housing owned or operated by the school.

Typically, a 529 plan cannot be used for transportation costs, but special needs students can use it for a broad array of expenses that include transportation.

Up to $10,000 can be used to pay student loan debt for the beneficiary, siblings, and step-siblings.

Up to $10,000 per-year can be used for K-12 tuition. However, think carefully before using 529 funds for K-12 tuition. Some states do not conform to this provision, so on the state tax return, the earnings portion of the distribution may be taxable. Plus, some states may impose a penalty.

What to do with leftover funds

One use to consider for leftover money in a 529 plan is to pay for graduate school. That includes law school, medical school, business school — even getting a masters in tax or accounting.

There is no tax consequence if the beneficiary of a 529 plan is changed to another family member, broadly defined. This includes spouses, first cousins, descendants, and siblings.

Plan owners can leave their 529 to others at death. Unlike IRAs and health savings accounts, 529 plans can exist in perpetuity. But unlike IRAs, there are no required minimum distributions.

Under the SECURE 2.0 Act, it will soon be possible to perform a rollover from a 529 educational savings plan to a beneficiary’s Roth IRA up to a certain dollar limit.

Part II: 529 Rollovers

There are more than 90 new retirement plan provisions in the SECURE 2.0 Act, which was signed into law on Dec. 29, 2022, as part of the Consolidated Appropriations Act, 2023, P.L. 117-328, but one in particular has generated a lot of interest among CPAs, financial planners, and clients.

Under the SECURE 2.0 Act, it will soon be possible to perform a rollover from a 529 educational savings plan to a beneficiary’s Roth IRA up to a certain dollar limit. Many of our clients have leftover money in their 529 plans after their children finish college and may be able to use this new rollover provision.

If you know anyone who was attending college in the early days of the COVID-19 pandemic, you know that students were sent home to virtually finish out the semester — and for some, the next year.

Although their tuition costs did not change, many students no longer needed to pay for on-campus housing. Accordingly, they may have money left over in the 529 plan they had been using to pay for college.

Here’s what you need to know about the new 529-to-Roth rollover provision:

This provision takes effect in 2024, not 2023.
The 529 plan must be open for at least 15 years.
The lifetime limit for the rollover is $35,000 per beneficiary.
The Roth IRA must be in the name of the beneficiary of the 529 plan.
Any contributions made within the past five years (and earnings on those contributions) are ineligible to be moved into the Roth IRA.
The annual limit on the rollover is the IRA contribution limit for the year, less any other IRA contributions.
- If the beneficiary made any IRA contributions, the rollover amount must be reduced by those contributions.
- Consequently, getting to the $35,000 lifetime limit may take more than five years.
The rollover must be a plan-to-plan or trustee-to-trustee rollover. This means you cannot take a check from the 529 plan to deposit into the IRA.
The beneficiary is not subject to income limitations to contribute to a Roth IRA.
The beneficiary must have earned income, and the amount that can be rolled over is the lesser of earned income or the IRA contribution limit. If the beneficiary is not earning income, no rollover is available.

Part III: Planning with 529s

Are you thinking about opening a 529 for a newborn?

It’s a good idea, and the new 529-to-Roth rollover provision helps address the risk of having leftover funds in the account. Whenever a client has a new child, we always recommend they open a 529 plan and invite friends and family to make contributions.

Grandparents can be encouraged to take advantage of “superfunding” a 529. This is a special provision that allows anyone to contribute five years of the annual gift exclusion amount into the 529 plan without any gift tax consequence. For 2023, the annual gift exclusion is $17,000. Therefore, the superfunding 529 contribution would be $85,000 (5 × $17,000). Although there is no taxable gift, a Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, still needs to be filed, reporting the contribution to the 529 plan by checking the box in line B of Schedule A on the second page of the form and attaching the required explanation.

The donor also needs to outlive the gift by five years for this to be considered a completed gift. If the donor passes away during the five-year period, then the portion of the incomplete gift will be added back to the donor’s estate. For example, grandmother contributed $85,000 to her new grandchild’s 529 plan in 2023. She passes away in 2025, so $34,000 (2 × $17,000) will need to be added back to her taxable estate.

If a 529 plan is started when the child is born, at age 16 the funds will have been in the 529 plan for at least 15 years. Once the child is working, they can start moving the money from the 529 to a Roth IRA, if desired. The rollover can be helpful especially in situations in which the child is awarded a scholarship or the expenses are less than anticipated for whatever reason.

You can keep making 529-to-Roth rollovers until the $35,000 lifetime transfer limit is reached.

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