What Are the Tax Benefits of a 529 Plan?
Contributions are not federally deductible, but over 30 states offer state income tax deductions or credits. Earnings grow tax-free, and qualified withdrawals owe no federal or state income tax. This triple tax benefit (state deduction, tax-free growth, tax-free withdrawal) makes 529s the most tax-efficient education savings vehicle available.
What Happens If 529 Funds Are Not Used for Education?
Non-qualified withdrawals incur income tax plus a 10% penalty on the earnings portion. However, starting in 2024, unused 529 funds can be rolled into a Roth IRA for the beneficiary (up to $35,000 lifetime, subject to annual Roth contribution limits and a 15-year account age requirement). Beneficiaries can also be changed to other family members.
How Should You Invest Within a 529 Plan?
Most 529 plans offer age-based portfolios that automatically shift from aggressive to conservative as the beneficiary approaches college age — similar to a target-date fund. You can also choose static allocations. Keep time horizon in mind: longer horizons can tolerate more equity exposure.
Frequently asked questions
Do 529 plans affect financial aid?
Parent-owned 529 plans are counted as parental assets on the FAFSA, assessed at a maximum rate of about 5.6% — much lower than student-owned assets. Distributions from parent-owned 529s are not counted as student income, minimizing financial aid impact.
Can grandparents contribute to a 529 plan?
Yes. Anyone can contribute to a 529, and grandparent contributions are a popular estate planning tool. Contributions qualify for the gift tax annual exclusion, and a special provision allows five years of gifts to be front-loaded in a single year.