What is a 529 plan and how is it used?
A 529 plan is a tax-advantaged account designed to help families save for future educational expenses, particularly college. Funds invested in a 529 plan grow on a tax-deferred basis and can be withdrawn tax free for many qualified expenses at an eligible institution. Examples of qualified expenses that can be paid
are:
- Tuition
- Fees
- Books
- Computers and associated software
- Room and board
There are two main types of 529 plans: college savings plans and prepaid tuition plans. College savings plans are the most common. In this type of 529, the account holder can select a variety of investment options, typically mutual funds. The performance of the chosen investments determines the account’s growth. As such, consideration should be given to the selected investment as well as individual risk tolerance. Prepaid tuition plans are much less common. These plans allow families to lock in tuition rates at today’s prices, serving as a hedge against inflation. Prepaid tuition plans only allow for tax-free withdrawals at a limited number of institutions, typically public universities within a given state.
What happens if the beneficiary does not go to college?
This is perhaps the most common concern when planning contributions to a 529 plan. However, there are numerous safeguards in place to ensure that the money can be used in a tax-efficient manner. Some examples of other ways to use funds are:
- Qualified postsecondary credentialing expense including apprenticeship programs/trade school/certification programs
- Change the beneficiary (nontaxable event)
- Qualified K-12 expenses (limited to $20,000 per year starting in 2026)
- Roth IRA Conversion ($35,000 lifetime limit and other restrictions)
Are there any other tax issues to consider with a 529 plan?
When funding a child’s (or another person’s) 529 plan, it is important to note that the gift could potentially be taxable. Gift taxes are discussed in a separate article. Payments made directly to an educational institution are not considered taxable gifts; however, gifts to a 529 plan are subject to gift taxes. A special election exists so that a contribution to a 529 plan can be frontloaded or “super funded.” A taxpayer can elect on a timely-filed gift return to spread a 529 gift over a five-year period. For 2026, this allows a taxpayer to make a $95,000 gift to a 529 plan in 2026 without incurring taxable gifts. The gift would be treated as five gifts of $19,000 in each tax year from 2026 through 2030, which is equal to the current annual gift tax exclusion. Assuming that the sum of all other gifts to the recipient in each subsequent year is below the annual exclusion, a gift tax return is only required in the year of the election. Additionally, if the taxpayer’s spouse consents to gift splitting, the amount of tax-free gifts that can be made doubles.
Other cautions of using a 529 plan:
- Non-qualified withdrawals – If the funds are used for a non-qualified expense, the earnings from the plan are subject to income tax as well as an additional 10% penalty.
- Timing – The tax advantages of a 529 plan work best when time and compound interest can work in its favor. Contributing to a 529 plan within a year or two of its expected use will offer limited benefits.
- Market Risk – 529 plans are frequently invested in stocks and bonds which carry market risk. Consider consulting with a reputable licensed financial advisor.
- State taxability – Rules for 529 plans vary by state and certain withdrawals may be taxable at a state level despite no federal income taxation.
529 plans can be a powerful tool for education planning, but they require careful consideration of timing, investment choices, and tax implications. By planning early and understanding the rules, families can maximize the benefits of a 529 plan and reduce the financial stress of education costs. If you have questions regarding whether a 529 plan meets you and your family’s tax situation, contact the professionals at Gilliam Bell Moser today!
