Investing in 529 Plans for Education and Estate Planning

529 plans are best known as education investment accounts with three standout benefits: their contribution limits are much higher than comparable investment options, earnings and distributions are tax-exempt, and anyone at any income level is allowed to invest. Authorized in 1996 by Section 529 of the Internal Revenue Service (IRS) code, the official name of 529 plans is Qualified Tuition Programs (QTPs).

However—although there are financial penalties for using the funds for anything other than qualified higher education expenses (QHEEs)—the high contribution limits combined with major expansions of the tax-exempt status of QTPs have made 529 plans increasingly attractive to some investors as investment vehicles for non-educational purposes, including estate planning.

The catch is that the only 529 investors in a position to profit from all the benefits of QTPs are those who can afford to contribute up to limit and pay the penalties if the funds are eventually used for non-QHEE purposes. In fact, some certified financial planners (CFPs) and policy experts have argued that—unless an investor is in a high-income tax bracket—the benefits of 529 plans are minimal—even as savings plans for their original intended purpose: future college costs.

Here is an overview of important considerations for any investor considering a 529 plan.

Key Takeaways

  • The standout benefits of 529 plans include high contribution limits and tax-exempt earnings and distributions.
  • 529 plans are usually established by parents or grandparents on behalf of a child or a grandchild, but anyone can set up the plan and the beneficiary can be anyone they designate—including themselves.
  • If the 529 funds are used for non-educational purposes, the account owner will be hit with two financial penalties: a 10% fine and capital gains tax on the earnings.
  • Updates to the tax code expanded the approved uses of 529 distributions to include K-12 education and the repayment of up to $10,000 of student loan debt.

What Are 529 Plans?

There are two types of 529 plans: 1) education savings plans, the most common 529 vehicles, allow the account owner to open an investment account to save for the account beneficiary’s future education expenses; and 2) prepaid tuition plans, offered only by a few states, allow the account owner to purchase units or credits at participating colleges or universities for the account beneficiary’s future tuition—at current prices.

Qualified Higher Education Expenses (QHEEs): One important difference between the two types of 529 investment vehicles is that most prepaid tuition plans cover only tuition—and the education savings plans also cover room, board, books, computers, and mandatory fees/supplies as qualified higher education expenses (QHEEs).

Account Owners and Account Beneficiaries: Although 529 plans are usually established by parents or grandparents on behalf of a child or a grandchild—anyone who sets up the plan is the account owner—and the account beneficiary can be anyone designated by the account owner—including themselves.

How 529 Plans Work: Although 529 plans must be funded with after-tax dollars, the money grows completely tax-free (i.e., no tax on investment earnings) and the money taken out for qualified education expenses is completely tax-free as well. If the 529 funds are used for non-educational purposes, the account owner will be hit with two financial penalties: 1) a 10% fine; 2) income tax on the earnings (but not on the original contributions, which were already taxed).

State Tax Deductions: Investors should also be aware that each state has its own tax codes for 529 plans. For example, some states considered contributions tax deductible only for residents of the state sponsoring the 529 plan; some states allow a state tax deduction for any 529 plan, no matter the state of residency.

K-12 Education: A series of updates to the U.S. tax code in 2017, 2019, and 2020 included the expansion of 529 plan distributions from exclusively the postsecondary level to qualified educational expenses at the elementary and secondary level in public, private, and religious schools.

Student Loans: In 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) act added an important benefit: 529 plan distributions of up to $10,000 can be used to repay qualified student loans of the beneficiary—plus an additional $10,000 to pay the loans of each of the beneficiary’s siblings. (The $10,000 maximum is a lifetime—not an annual—limit.)

Tax-Exempt Status of 529 Plans: Since QTPs were codified in 1996, the federal tax status of earnings in 529 plans has expanded from tax-deferred to tax-exempt, originally as a temporary provision of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). Within five years, earnings growth in 529 plans was granted permanent tax-exempt status as part of the Pension Protection Act of 2006.

All 529 plans have federal tax benefits, but they are sponsored at the state level by state governments, state agencies, or state educational institutions. All 50 U.S. states and the District of Columbia sponsor at least one of the two types of 529 plans; some private colleges and universities sponsor prepaid tuition plans.

High Contribution Limits Are a Major 529 Benefit

A common topic of debate among investment advisors is whether 529 plans are better than other investment options (such as traditional IRAs or Roth IRAs) to cover future education expenses. However, one strong advantage of 529 plans is indisputable: the contribution limits are significantly higher than comparable accounts.

Although the limits vary by state, as of July 2022, all 529 plans have a maximum lifetime (not annual) contribution limit of at least $235,000—and some states set limits at $500,000 and above—compared to the annual maximum of $6,000 ($7,000 if over age 50) in a traditional individual retirement account (IRA) or a Roth IRA.

What this means for investors is that, if a parent starts investing in an IRA as soon as their child is born and continues for 18 years at the IRA maximum of $6,000 per year (until the child is college-age), the most that parent will have contributed is $108,000—approximately half the amount allowed in the states at the low end of the 529 maximum ($235,000) and less than a quarter of the amount allowed in states at the high end (over $500,000).

State-Specific Contribution Limits on 529 Plans

As state-sponsored investment vehicles, each state is allowed to set its own contribution limits. The College Savings Plans Network (CSPN), an affiliate of the National Association of State Treasurers (NAST), operates a find-my-state’s-529-plan tool to allow prospective investors to look up contribution limits and research plans in all 50 states and the District of Columbia.

For example, as of July 2022, the 529 maximums range from $235,000 at the low end (Georgia and Mississippi) to $529,000 at the high end (California). Other states with high contribution limits include Louisiana, Michigan, Washington, and the District of Columbia ($500,000) and Pennsylvania ($511,758) as well as South Carolina and New York (both at $520,000). Once the balance limit is reached, any contributions made to the account will be returned to the investor.

529 Plans for Wealth Transfer and Estate Planning

As mentioned above, the primary benefits of 529 plans for all investors are that earnings and distributions are 100% tax-free (unless used for non-educational purposes) and the contributions limits are quite high. However, there are significant (but less publicized) benefits of 529 plans that make them much more profitable for some investors, including certain allowances (for multiple accounts and front-loading) and federal tax exemptions on estates and gifts.

In fact, a 2021 Barron’s article described certain benefits as tax “loopholes” that make 529 plans “flexible…(and) effective wealth-transfer…(and) estate-planning tools.” The article quoted certified public accountants (CPAs), estate lawyers, and financial planners on the subject of the profitable uses of 529 plans “beyond education spending”—especially for high-income families trying to lower their taxable income and reduce their estates to limit estate taxes. Here is how it works.

Front-Loading 529 Plans

Although the IRS has set an annual limit of $15,000 on gifts per beneficiary per year ($30,000 for spouses), there is a gift-tax exemption that allows 529 plans to be front-loaded with amounts over that annual limit—with no gift-tax consequences. For example, a 529 investor can front-load the account with up to five years of contributions in one year ($75,000 or $150,00 for spouses), and the IRS will count that total as paid over five years. Of course, there can be no additional 529 contributions to the same beneficiary during that five-year period without gift-tax penalties.

Not only does the investor reduce their taxable income by $75,000 (or $150,00 for spouses) that year, but the earnings on the larger balance given in one lump sum will also be much higher than the earnings on smaller amounts given in yearly increments. Even though the total amount contributed in each scenario is exactly the same, front-loading the account with five years of contributions allows time for the magic of compound interest to drive much higher earnings growth.

As always, although the advantages of front-loading can be significant, each taxpayer's situation is different, so all investors should consult a tax professional to determine whether front-loading a 529 plan makes sense.

Multiple 529 Accounts in Different States

Another major benefit of 529 accounts is that the high contribution limit applies to each beneficiary within each state—but not across states—so one beneficiary can have the maximum saved on their behalf in multiple states. This means that parents can contribute up to the maximum in one state—for example, $500,000 in New York—and the same parents can contribute $500,000 for the same beneficiary in another high-limit state—for example, $500,000 in South Carolina. There are also no limits on the number of accounts that a 529 investor can have, so a grandparent with ten grandchildren can have 529 accounts for each one.

529 Plans Are Revocable

One certified public accountant (CPA), who called 529 plans “the most underutilized estate-planning technique,” explained that—unlike most investment vehicles designed to reduce the size of an estate—529 plans are revocable. For a relatively small fine and tax penalty, 529 account owners can always get the funds back, even for non-educational purposes. On the other hand, with traditional estate-planning tools like irrevocable trusts, investors lower their taxes by moving assets out of their own estates into trusts that cannot be modified, amended, or terminated without the permission of the beneficiary.

529 Investors Control the Account

Another financial advisor quoted in the Barron’s article pointed out that 529 investors have an even more interesting benefit than the revocable feature: they have complete control over the account. This means that the 529 account owner can change the beneficiary multiple times—or even change the owner—without triggering gift taxes, as long as they are in the same family. In other words, the owner can change beneficiaries as often as they wish and a grandparent can transfer ownership to the parent of the beneficiary—and the same rights will transfer to the new owners down the generations. This tax “loophole” allows investors to move “tax-free money pots” across the generations to fund the education of children, grandchildren, and beyond.

The Impact of 529 Plans on Estate and Gift Taxes

The Barron's article repeats the IRS caution that there are two important federal tax considerations for 529 plans: estate taxes (on transfers of the investor’s property at death) and gift taxes (on transfers of property during the investor’s lifetime). Property includes all assets of value, e.g., money, real estate, investment portfolios, jewelry, art—and 529 contributions.

The reason that estate and gift taxes are considered together is that—as of 2022—they are subject to the same tax rate (40%) and the same lifetime exemption amount ($12.06 million). What this means is that a taxpayer with assets in excess of the exemption limit ($12.06 million) will pay a tax rate of 40% on the amount above that limit that they either give away during their lifetime or leave for their heirs in their estate.

Estate and gift tax rates change often—and will change again in 2026 under current law, according to the U.S. Congressional Budget Office (CBO). As of July 2022, the same tax rate (40%) and the same lifetime exemption amount ($12.06) apply to both estates and gifts. Although CBO has projected that the exemption amount will drop to $6.4 million in 2026, Congress controls taxation, so there are no guarantees. However, until 2026, the transfer of gifts and estates will benefit from the higher tax exemption.

Are 529 Plans the Best Option?

Although the IRS gives 529 investors in every tax bracket all the rights listed above—the lower the tax bracket, the lower the funds available to take full advantage. In fact, investment advisors ranging from certified financial planners (CFPs) posting in Time Magazine to policy experts at the Brookings Institution have argued that—unless an investor is in a fairly high income-tax bracket—the benefits of 529 plans are often minimal compared to other investment options.

One reason is that the 529 benefits that deliver such large advantages in high tax brackets—multiple accounts in different states, front-loading accounts with large contributions, the wealth-transfer and estate-planning options—do not deliver value to investors who are not in a financial position to maximize them.

For example, according to the U.S. Congressional Budget Office (CBO), only 2% of U.S. taxpayers had taxable estates valued above $12.5 million in 2016 (the year of the most recent analysis)—so the wealth-transfer and estate-planning benefits of 529 plans are not relevant for most investors.

Another consideration is that—unlike high-income investors—taxpayers who need to use the 529 distributions for non-educational purposes will feel the pain of the 10% penalty and the income tax on earnings much more. (However, for investors with income below certain levels—$40,400 for single filers or $80,800 for married couples filing jointly—capital gains are taxed at 0%.)

As with any investment decision, all investors should consult a financial advisor and/or tax professional to determine whether 529 plans are the best option.

What Are the Contribution Limits on 529 Savings Plans?

The limits vary by state, but all 529 plans have a lifetime contribution limit of at least $235,000—and some states set limits at $500,000 and above (as of July 2022).

Can the 529 Plan Owner or Beneficiary Be Changed?

Yes, the 529 account owner has the right to change the beneficiary or the owner multiple times without triggering gift taxes—as long as they are in the same family.

What Does Front-Loading a 529 Plan Mean?

Front-loading is an IRS exemption that allows 529 owners to exceed the annual gift limit of $15,000 without triggering gift taxes. For example, a 529 investor can front-load the account with up to five years of contributions in a one-time, lump-sum contribution of $75,000—and the IRS will count that total as paid over five years—with no gift tax consequences.

Article Sources
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  2. U.S. Securities and Exchange Commission. “Investor Bulletin: An Introduction to 529 Plans.”

  3. U.S. Securities and Exchange Commission. “Investor Bulletin: 10 Questions to Consider Before Opening a 529 Account.”

  4. U.S. Congress. “Economic Growth and Tax Relief Reconciliation Act of 2001.”

  5. Invesco. “CollegeBound 529: Qualified Expenses and Legislative Changes.”

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  7. Internal Revenue Service. “Retirement Topics—IRA Contribution Limits.”

  8. The College Savings Plans Network. “Find My State's 529 Plan.”

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  10. Internal Revenue Service. “Publication 970, Tax Benefits for Education.”

  11. Internal Revenue Service. “Estate Tax.”

  12. U.S. Congressional Budget Office. “Understanding Federal Estate and Gift Taxes.”

  13. The Brookings Institution. “A Tax Break for Dream Hoarders: What to Do About 529 College Savings Plans.”

  14. Time NextAdvisor. “I’m a CFP and a Mom. Here’s Why I’m Not Investing in a 529 Plan for My Kid.”

  15. Internal Revenue Service. “Topic No. 409: Capital Gains and Losses.”

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