If you read this title and thought, “Man, 529 Accounts seems like a whole lot of accounts for one person, and why is such an oddly specific number?”, then you have stumbled upon the right blog post.
If you have ever sat uncomfortably quiet when your buddies at the bar are discussing funding options, well, first…you need more fun friends. That I can’t help you with much, other than to help you dazzle them the next time the topic comes up.
Established under section 529 of the Internal Revenue Code, these accounts are state sponsored qualified educational savings accounts designed to help save and pay for higher education costs.
What makes them qualified? Well, obviously you get a tax deduction for contributing to them, right? Nope. There is not a federal tax deduction available upon contributing to a 529 account. Why would you do it then?
It is all about the growth. Even though a federal deduction is not received upon contribution, these accounts function similarly to ROTH IRAs. You are allowed to invest the contributions in securities and then the growth of the money invested in the accounts is not taxable while it remains in the 529 accounts. Your contribution grows, tax free. Then, if you withdraw the money for “qualified educational expenses”, the distributions are not taxable as income.
“Well the government must really limit what are qualified higher educational expenses if they are offering a deal that good!”
(Adjusts nerd glasses) Actually the tax law is surprisingly generous as to what is permitted to be paid for from a 529 account. The following expenses are deemed qualified:
Tuition
Fees
Books
Supplies
Equipment
Room & Board (also off-campus rent)
Higher education can be for any 2 year or 4 year program after high school and you can even use up to $10,000 per year to pay for private secondary school education as well.
This may seem like a trick, but the government is attempting to encourage citizens to invest in education. And we are taking advantage of the program. As of the end of 2024, $508 Billion with a B have been invested in 529 plans.
And that’s not all, while there isn’t a federal tax deduction available for 529 plan contributions, many states do offer a deduction for state income tax. The deduction and limitations vary by state so you want to be sure to check your home states rules. They generally aren’t home run sized deductions but take the money where you can.
“Yeah, but what happens if my kid gets a scholarship or doesn’t use all of the money?” No need to fear, you don’t necessarily lose the benefits. You can assign a different beneficiary – a younger sibling perhaps – to the account instead, without tax consequence. There may be family issues to deal with but you are clear on the tax part. Another option if you run out of potential beneficiaries is to roll the 529 funds into a Roth IRA account.
The Secure Act 2.0 granted the option to roll unused 529 account funds into a Roth IRA if the 529 account has been open for at least 15 years. The total amount rolled over can’t exceed $35,000 and you can’t rollover any contributions made in the last 5 years. There are a few other rules so be sure to check with a qualified advisor on eligibility.
“This all sounds great, but how do we get money in there?” Great question. In the funding discussion, we need to touch on gift tax rules. You may not have known that there can be a tax on gifts. Two tax types in one blog post – man did you hit the jackpot.
We won’t get too into gift tax here, but the government has a tax in place to make sure wealthy individuals don’t dodge the estate tax too much by giving money to their decedents. There are several exceptions and planning techniques to help reduce liabilities but those aren’t for this post. One exception to the gift tax is the annual exclusion. This is important since contributions to a 529 account are technically a gift to the beneficiary. The annual gift tax exclusion is an amount of money that changes with inflation most years that permits you to give to any individual without ever having to worry about the gift tax. For 2025 and 2026, the annual exclusion amount is $19,000. So you can put up to $19,000 into a 529 account for any number of beneficiaries without ever worrying about gift tax. You do need to check your state rules though. Just because this is the federal limit doesn’t mean you can take a state tax deduction for the full amount. Some states have caps on the deduction you can claim for 529 account contributions.
There is also a special rule for 529 accounts that allow you to “superfund” them. Sounds pretty spectacular right? This rule for 529 accounts allows you to fund up to 5 times the annual exclusion amount in year 1 and then treat that as being contributed over 5 years for gift tax purposes, meaning you don’t have to worry about gift tax if you don’t give the beneficiary anything else during that time period. This “super funding” option allows your contributions to be invested and start growing tax free sooner than making that contribution each year over the next 5 years.
This wraps up our primer on 529 accounts. Hopefully, you can now impress your friends at Christmas parties. If this sounds like something you’re interested in, please reach out to a qualified professional. Again, this is just a blog and not to be taken as tax advice.