While 529 college savings accounts seem relatively straightforward, there are a number of little-known facts about these accounts that can be used for advanced wealth planning, tax strategy, and avoiding common pitfalls when taking distributions from these accounts.
1: Roth Transfers Will Be Allowed Starting in 2024
Starting in 2024, the IRS will allow direct transfers from 529 accounts to Roth IRAs. This is a fantastic new benefit that opens up a whole new basket of multi-generation wealth accumulation strategies for families.
2: Anyone Can Start A 529 Account For A Child
Do you have to be the parent of the child to open a 529 account? No. 529 account can be opened by parents, grandparents, aunts, or friends. Even if a parent has already established a 529 for their child there is no limit to the number of 529 accounts that can be opened for a single beneficiary.
3: State Tax Deduction For Contributions
There are currently 38 states that offer either state tax deductions or tax credits for contributions to 529 accounts. Here is the list. There are no federal tax deductions for contributions to 529 accounts. Also, you don’t have to be the parent of the child to receive the state tax benefits.
4: A Tax Deduction For Kids Already In College
For parents that already have kids in college, if you have not already established a 529 account and you are issuing checks for college tuition, for states that offer tax deductions for contributions, you may be able to open a 529 account, contribute to the account up to the state tax deduction limit, and as soon as the check clears, request a distribution to pay the college expenses. This allows you to capture the state tax deduction for the contributions to the account in that tax year.
5: Rollovers Count Toward State Tax Deduction
If you just moved to New York and have a 529 with another state, like Vermont, you are allowed to roll over the balance of the Vermont 529 account into a New York 529 account for the same beneficiary and those rollover amounts count toward the state tax deduction for that year. We had a New York client that had a Vermont 529 for their daughter with a $30,000 balance, and we had them rollover $10,000 per year over a 3-year period to capture the maximum NYS 529 state tax deduction of $10,000 each year.
6: Not All States Allow Distributions for K – 12 Tuition Expenses
In 2018, the federal government changes the tax laws allowing up to $10,000 to be distributed from a 529 account each year to pay for K – 12 tuition expenses. However, if you live in a state that has state income taxes, states are not required to adopt changes that are made at the federal level. There are a number of states, including New York, that do not recognize K – 12 tuition expenses as qualified expenses so the earnings portion of those withdrawals would be subject to state income tax and recapture of the tax deductions that were awarded for those contributions.
7: Transfers Between Beneficiaries
529 rules can vary state by state but most 529 accounts allow account owners to transfer all or a portion of balances between 529 account with different beneficiaries. This is common for families that have multiple children and a 529 account for each child. If the oldest child does not use their full 529 balance, all or a portion of their 529 account can be transferred the 529 accounts of their younger siblings.
8: Contributions Can Be Withdrawn Tax and Penalty Free
If you ever need to withdraw money from a 529 account that is not used for qualified college expenses, ONLY the earnings are subject to taxes and the 10% penalty. The contributions that you made to the account can always be withdrawn tax and penalty-free.
9: 529 Accounts May Reduce College Financial Aid
The balance in a 529 account that is owned by the parent of the student counts against the FAFSA calculation. Fortunately, assets of the parents only count 5.64% against the financial aid award, so if you have a $50,000 balance, it may only reduce the financial aid award by $2,820. However, 529 accounts owned by a grandparent or another relative, are invisible to the FAFSA calculation.
10: Maximum Balance Restrictions
529 plans do not have annual contribution limits but each state has “aggregate 529 plan limits”. These limits apply to the total 529 balances for any single 529 beneficiary in a particular state. Once the combined 529 plan balances for that beneficiary reach a state’s aggregate limit, no additional contributions can be made to any 529 plan administered by that state. Luckily, the limits for most states are very high. For example, the New York limit is $520,000 per beneficiary.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Frequently Asked Questions (FAQs):
Can 529 plan funds be rolled into a Roth IRA?
Yes. Starting in 2024, the IRS allows direct transfers from 529 plans to Roth IRAs under certain conditions. This rule lets unused education savings continue growing tax-free for retirement, offering families a powerful long-term wealth planning opportunity.
Who can open a 529 plan for a child?
Anyone—not just parents—can open a 529 plan for a child. Grandparents, relatives, and even family friends can establish and contribute to an account. Multiple 529 plans can exist for the same beneficiary, allowing flexible savings options across family members.
Do 529 plan contributions qualify for tax deductions?
There is no federal tax deduction for 529 plan contributions, but 38 states currently offer a state income tax deduction or credit. You don’t need to be the child’s parent to claim the state tax benefit if you are the account owner making the contribution.
Can parents claim a 529 deduction if their child is already in college?
Yes. In many states, parents can open and fund a 529 account, then immediately use the funds to pay qualified college expenses. This strategy captures a same-year state tax deduction while paying existing tuition bills.
Do 529 rollovers from another state qualify for tax deductions?
Often, yes. Some states, such as New York, allow rollovers from out-of-state 529 plans to count toward the annual state tax deduction limit, provided the funds remain for the same beneficiary.
Are K–12 tuition payments allowed from a 529 plan?
Federal law permits up to $10,000 per year in 529 withdrawals for K–12 tuition, but not all states recognize this as a qualified expense. In states that don’t, earnings may be subject to state income tax and potential deduction recapture.
Can 529 funds be transferred between children?
Yes. Most 529 plans allow tax-free transfers between siblings or other qualifying family members. This flexibility helps families reallocate unused education funds among multiple children.
What happens if 529 funds are used for non-education expenses?
Withdrawals of contributions are always tax- and penalty-free. However, earnings withdrawn for non-qualified expenses are subject to ordinary income tax and a 10% federal penalty.
Do 529 plans affect college financial aid eligibility?
Yes, but the impact is small. Parent-owned 529 assets count as parental resources on the FAFSA and reduce aid eligibility by only 5.64% of the account’s value. 529 plans owned by grandparents are not reported on FAFSA but may affect aid when distributions are made.
Is there a maximum amount you can save in a 529 plan?
While there’s no annual contribution limit, states impose aggregate balance limits per beneficiary, typically exceeding $400,000. For example, New York’s limit is $520,000 per student, after which no additional contributions can be made.
