Broker Check
Make the Most Out of a 529 Plan

Make the Most Out of a 529 Plan

November 15, 2023

Decent Solutions do exist for spending unused funds in a 529 Education Savings Plan


Section 529 Plans offer virtually anyone an attractive means of saving for education. Funds placed in a 529 Plan grow tax-free and are distributed tax-free when used for qualified education expenses. There are no income limits on contributions, allowing even high-income earners to save for education in this tax-advantaged manner.

Individuals can contribute up to the annual gift exclusion amount, and married couples can contribute double that amount ($17,000/$34,000 in 2023) without filing a gift tax return or paying gift tax. Alternatively, one can combine five years of contributions into a single year. For example, an individual may contribute up to $85,000 (or $170,000 as a couple) in one year, reporting the 5-year election on the IRS form 709 for the following five years. State-specific contribution limits to 529 Plans range from $235,000 to $531,000.

Distributions are tax-free when used for qualified expenses like tuition, required electronic devices, and books. Students enrolled at least half-time in an eligible institution can make qualified distributions to cover room and board. Since 2017, a qualified distribution of up to $10,000 can be made for tuition/fees for K-12 schooling. Additionally, the Secure Act of 2019 allows using 529 funds to pay up to $10,000 in student loans.

While 529 Plans are potent savings and investment tools due to their tax-advantaged status, some individuals hesitate to contribute fully due to spending restrictions. If funds are not used for qualified education-related expenses, earnings become subject to tax and a 10% penalty. Under-contributing to a 529 Plan may cost more in the long run by missing out on tax-free investment earnings.

To address this concern, individuals should familiarize themselves with the flexibility of 529 Plans and understand solutions for unused funds. Account owners can easily change beneficiaries, with the new beneficiary being a qualified family member. Switching between the same beneficiaries is also allowed.

When a beneficiary receives a scholarship or uses GI Benefits, an account owner may withdraw funds without the 10% penalty, though tax will be due on the withdrawals. The penalty-free withdrawal must match the scholarship or benefit amount. 529 Plans can remain open indefinitely, enabling the use of funds for graduate school, a grandchild's education, or the account owner's own educational pursuits.

A recent concession allows account owners of some plans to roll over up to $35,000 during their lifetime to a Roth IRA in the beneficiary's name. This option becomes available in 2024, with plans needing to be open for 15 years to qualify. Contributions made within five years of the rollover are ineligible, and the account must be for a child's benefit.

Despite these allowances, spending restrictions on 529 Plans may deter some individuals, considering other financial priorities like retirement savings. While 529 Plans offer the opportunity to supercharge college savings with tax-free investment income, they should be weighed against more flexible investment options. Evaluating the potential tax-free income in the context of a family's general tax liability helps determine if the restrictions are worthwhile.

When deciding on a 529 Plan and contribution amounts, it's advisable to consult with a CPA, review your state's 529 Plan rules, and seek guidance from your financial advisor. At Pacific Wealth Management, we provide advice tailored to your circumstances and priorities.

Download the Full Report