Investing in Education with 529 Plans

Key Takeaways:

•  529 plans feature significant benefits for affluent families, including tax-free growth, estate planning advantages and built-in creditor protection in many cases.
• Common concerns about 529 plans, such as overfunding, limited investment choices and potential impacts on financial aid, can be effectively managed with careful planning.
• To make the most of a 529 plan, discuss your goals and concerns with a financial advisor.

Planning for education is more than a necessity; it’s a smart financial move.

Affluent families may have the resources to cover education costs out-of-pocket. But taking advantage of financial tools, like a 529 plan, for college savings may still be worthwhile.

Incorporating a 529 plan into your financial strategy can provide valuable tax advantages, estate planning benefits and strong financial flexibility — all while securing your loved ones' future education. With the 2024 introduction of a 529-to-Roth rollover, there are even more options for funds that are not used for education.

In this article, we will explore 529 plan fundamentals, the value they provide for affluent families and recent updates. We will also highlight the benefits and address common concerns, like overfunding and penalties, to show why a 529 plan may be a smart addition to your financial strategy.

529 Plan: The Fundamentals

A 529 plan is a tax-advantaged savings plan designed to help families save for future education costs. Unlike traditional savings accounts, 529 accounts are designed to support long-term growth, making them an effective way to prepare for the rising costs of higher education.

Whether you’re planning for your child, grandchild, or even yourself, a 529 plan offers a simple tool to make sure college expenses are covered when the first bill comes.

Types of 529 Plans

There are two types of 529 plans: prepaid tuition plans and education savings plans:

1. Prepaid tuition plans give you the ability to pay for future college tuition at today’s rates, effectively locking in the cost and protecting your savings from inflation. This plan is particularly helpful when you anticipate rising tuition fees and want to avoid the future cost of education.

2. Education savings plans, on the other hand, offer a more flexible approach. They allow you to invest money that grows tax-free over time. These plans give you the opportunity to choose from a variety of investment options. Funds accumulated in an education savings plan can be used for a wide range of education-related expenses, including tuition, room and board, books and more.

Additionally, 529 plans are not just reserved for higher education costs. They can also be used for K-12 education up to $10,000 per year at public, private and religious institutions.

Key Benefits of a 529 Education Savings Plan

A 529 education savings plan offers several key benefits that make it an attractive option for families at all income levels. Here are the main benefits affluent families should keep in mind:

• Tax-Free Growth

The money you invest in a 529 account grows tax-free, meaning you won’t pay taxes on the earnings as long as funds are used for qualified education expenses. To measure the estimated impact of tax-free growth, consider using a 529 calculator.

For example, let’s say you start saving on your child’s first birthday with a $1,000 initial investment and $250 monthly contributions. Then, assume a 7% rate of return on your investment.

By the time your child reaches college age, you would have $101,376 available. If you’d put the same amount into a traditional savings account, it would be $52,777 — representing 48% fewer dollars to cover education expenses.

It’s also worth noting that with a 529 plan you have access to a variety of investment options. Many 529 plan portfolios feature options including actively managed funds, blended funds and low-cost index funds. Account owners may choose the investment options, fees and platforms that meet their needs.

• Potential State Tax Deductions

There are no federal deductions for 529 contributions. But depending on the state, you and your loved ones may be eligible for state tax deductions or credits on your contributions. This makes your savings even more substantial.

At the time of this writing over 30 states offer tax deductions for qualifying 529 contributions. In most of these states, taxpayers have to contribute to their home state’s plan to take advantage of this deduction. Additionally, all but 7 of the states who offer tax deductions extend the deduction to grandparents and other loved ones.

• Flexible Use of 529 Funds

529 funds can be used to cover various education-related costs for K-12 and college, including tuition, room and board, books and supplies, offering flexibility in how the funds are applied.

If your child, for example, chooses to attend a lower-cost state school and live at home, funds can still be used for books, supplies and computer equipment. Funds may also be used for other school-run programs like travel abroad.

• Transfer and Rollover Options

Importantly, 529 accounts can be transferred to a new beneficiary with few restrictions. For the most part, you can transfer anytime as long as the funds move to a qualified family beneficiary. There are no limits on the number of times you can change the beneficiary.

529 plans also offer rollover options. If you find a different 529 plan that better suits your needs, want to change investment options, or need to roll over funds into another family member’s existing 529 account, you can do so without penalty. You are limited to one rollover per year.

Alternatively, you may be able to roll 529 funds into other investment vehicles. Under provision of the Secure Act 2.0, which became effective in 2024, 529 account funds can be rolled into a Roth IRA if you meet the guidelines.

Notable Guidelines for a Roth IRA Rollover Include:

• Beneficiary must be the same: The beneficiary of the 529 plan must be the same person as the owner of the Roth IRA. The rollover is only permitted if both accounts are held for the benefit of the same individual.
• Beneficiary’s earned income requirement: The beneficiary must have earned income at least equal to the rollover amount.
• 15-year holding period requirement: The 529 account must have been established for at least 15 years before any rollover can occur.
• Contribution timing and restrictions: Only contributions made more than five years before the rollover date are eligible for transfer. Recent contributions (within five years) cannot be rolled over, ensuring the account was funded for long-term education savings.
• Lifetime rollover cap: A maximum of $35,000 can be rolled over from a 529 plan to a Roth IRA for a single beneficiary throughout their lifetime. This prevents excessive use of 529 funds as a backdoor for retirement savings.
• Annual Roth IRA contribution limits apply: Rollovers must not exceed the beneficiary's annual Roth IRA contribution limit.

Lastly, the Tax Cuts and Jobs Act of 2017 allows 529 plan owners to roll 529 account funds into an ABLE account for a family member with special needs. However, without congressional action, that provision is scheduled to expire after 2025.

Estate Planning Advantages

For affluent families, a 529 plan provides more than education savings — it’s also a useful tool for estate planning.

One of the notable benefits is that contributions to a 529 plan can reduce the size of your taxable estate. When you contribute to a 529 plan, those funds are considered gifts, meaning they move out of your estate. This can help lower your potential estate taxes.

At the same time, if you are the “owner” of the account, you maintain control over funds. As the owner, you can determine the investment strategy, make distributions and change the owner and beneficiary of 529 funds.

Another advantage is the ability to “superfund” a 529 plan. In 2024, you can contribute up to five years’ worth of gifts at once — $90,000 per beneficiary — without triggering federal gift taxes. This allows you to move substantial assets out of your estate quickly, which is particularly beneficial if you are looking to reduce your estate tax exposure.

With a 529 plan as part of your estate planning, you can manage wealth more effectively while setting aside funds for your family’s educational needs.

Protection From Creditors

For affluent families, protecting assets is a major concern.

And the 529 plan may offer valuable safeguards. At the federal level, certain 529 plans are exempt from bankruptcy proceedings if the named beneficiary is the child, stepchild, grandchild or step-grandchild of the debtor.

Several states also shield 529 accounts from creditors in the event of bank or other financial issues. For example, in 2020 the California legislature added ScholarShare 529 Accounts to the list of exemptions under California bankruptcy law. For contributions made in the first and second years before a bankruptcy filing, only up to $15,000 per year (the maximum gift tax limit) is protected from creditors' claims.

By using a 529 plan, affluent families can add an extra layer of security to their financial strategy, protecting education savings from unforeseen circumstances.

To learn more about this type of protection, consult with your attorney.

The Psychological Benefits: Peace of Mind

A 529 plan offers something beyond financial advantages.

It offers peace of mind. Knowing you’ve set aside dedicated funds for your child’s or grandchild’s education can remove the stress and uncertainty that comes with planning for the future. Focus on other financial goals, confident that the costs of education are covered.

For affluent families, this peace of mind is invaluable. It helps you prioritize education funding without the burden of an overwhelming future bill.

Common Concerns

529 plans offer many benefits, but it’s understandable to have concerns. Affluent families should consider every angle of these plans before committing.

• Overfunding

Often, the most common concern is the risk of overfunding a 529 plan. If you save more money than what is needed for education expenses, you may worry about what happens to the excess funds.

The good news is you have options. As mentioned, you can change the beneficiary to another family member or even use the funds for your own education. You can also jump-start the beneficiary’s retirement fund by transferring the money to a Roth IRA. If none of these options meet your needs, you can withdraw the funds with a penalty applied to the earnings portion.

• Investment Options and Fees

You may also be concerned about limited investment choices and high fees associated with 529 plans. Paying high fees cuts into your investment growth, limiting your funds over time.

To overcome this, research and compare various state plans. Many offer low-cost, direct-sold options with diverse investment choices if that’s what you are looking for. Select a plan that will help you maximize growth and minimize hassle.

• Market Risk

Similarly, many families worry about the impact of the market on education savings. If the market tanks, will you still have enough funds to cover college?

Here, strong investment planning is the key. Families can choose age-based investment options that automatically adjust to a more conservative allocation as the beneficiary approaches college age. Diversifying investments within the plan also helps manage risk and protect against market downturns.

• Impact on Financial Aid

Another concern is that 529 plan balances are considered parental assets on the FAFSA, potentially reducing financial aid eligibility. When the 529 account is owned by a parent, these funds can reduce a student’s aid package by up to a maximum of 5.64% of the asset’s value.

A common workaround for this is to name someone other than a parent as the plan owner. By doing this, only the distributions from the plan are reported on the FAFSA form as a student's untaxed income, potentially reducing eligibility by up to 50% of the amount distributed.

Under the recent FAFSA Simplification Act, grandparents are now eligible to own 529 plans without the direct impact on student aid eligibility.

Concerns about 529 plans are valid. But with careful consideration and a clear understanding of how 529 plans work, they can be managed effectively. Consult with a financial advisor to make informed decisions that align with your family’s needs and goals.

Want to Discuss a 529 Plan with a Professional?

Our team of wealth professionals would be happy to review your education goals and discuss whether a 529 plan is the right savings option for you and your loved ones. To talk through your needs and identify next steps, contact Comerica Wealth Management.