By Dr. Jim Dahle, WCI FounderHere's a question I've gotten in the past and have been thinking about.
“I have three children: 18, 17, and 11. I would like to put some money away for college for them. Is it too late to bother with a 529?”
The Benefits of a 529 Plan
There are four significant benefits of using a 529 plan. Whether they are worth the additional hassle and expense of a 529 plan depends on your state, the length of time until the money is used, and your plans for unused money.
#1 An Upfront State Tax Break
Many states offer a tax deduction or credit for money contributed to their 529 plan (and a few states (Arizona, Minnesota, and Missouri) offer this benefit for a contribution to any 529 plan). (This chart is the latest information we have, but if you see something that's outdated, let us know in the comments).
Even if your kid is already 18 and you're taking the money out next week, it still makes sense to put it in a 529 if you get one of these tax deductions. But if you're in one of the tax-free states (Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, or Wyoming) or in one of the states that does not offer a tax deduction or credit (California, Delaware, Hawaii, Kentucky, New Hampshire, New Jersey, and North Carolina), then you can ignore this benefit.
#2 Tax-Protected Growth
Like a 401(k), Roth IRA, or HSA, money inside a 529 is not taxed as it grows. The elimination of this tax drag causes the money to grow faster. This benefit can really add up if the money will be in the account for a long time, especially if the money is growing rapidly (stocks) or is particularly tax-inefficient (REITs, bonds). Remember that an 18-year-old generally does not spend their entire 529 all at once. It may take 4-10 years for them to complete their education, and 10 years is a lot of tax-protected growth. Plus, if they don't use it all, the beneficiary can be changed to someone younger, potentially enabling decades more of tax-protected growth.
#3 Tax-Free Withdrawals
If the money is spent on education, the earnings on the account are never taxed. The more earnings, the more beneficial the 529 will be. But even if the earnings are minimal, the hassle of using a 529 is also pretty minimal. The only real risk there is that you would want to use the money for something besides education, in which case earnings would be subject to a penalty and ordinary income tax rates.
#4 Asset Protection
Some states offer additional asset protection to money in 529s. While the protection varies by state, this is an additional benefit of using a 529 in all of the following states:
- Alaska
- Arizona
- Colorado
- Florida
- Idaho
- Illinois
- Kansas
- Kentucky
- Lousiana
- Maine
- Maryland
- Nebraska
- Nevada
- New Jersey
- New York
- North Dakota
- Ohio
- Oklahoma
- Oregon
- Pennsylvania
- Rhode Island
- South Carolina
- South Dakota
- Tennessee
- Texas
- Virginia
More information here:
Best 529 Plans: Reviews, Ratings, and Rankings
How to Roll Over a 529 into a Roth IRA (and Is This a Good Idea?)
When Is It Too Late?
As you can see, in most situations, it is NEVER too late to use a 529. However, if you are in Washington state and, thus, get no tax break and no asset protection and you plan to use the 529 money for your 18-year-old's freshman year, then it's probably too late. But it would still be worth using a 529 for an 11-year-old.
How to Maximize 529 Benefits
You can maximize the benefits from your 529 by:
- Investing early (consider superfunding for infants)
- Leaving the money invested as long as possible by using leftover funds for the next generation
- Living in a state with a large upfront tax break
- Living in a state offering significant asset protection
- Investing aggressively (i.e. risky assets with expected high returns)
- Investing in tax-inefficient assets
- Using 529 assets only for educational purposes
The more of this you do, the more benefit you will get from a 529. The less of this you do, the less benefit you will see. But very few people will see zero benefit or have the use of a 529 actually hurt them.
More information here:
3 Reasons Why You Can Take More Risk with a 529
Despite Our Student Loan Debt, Here’s How We’re Filling Our Kids’ 529s
Lost Tax Breaks
Keep in mind there are a few tax breaks that you could lose by using a 529.
First, you can't tax-loss harvest assets in a 529. You can't donate them to charity either. These are nice benefits of a taxable account. And in the event that you don't use the money for education, there is a 10% penalty on earnings and you also must pay at ordinary income tax rates rather than the lower long-term capital gains and qualified dividend rates.
Second, if you pay for education with 529 funds, you cannot also claim The American Opportunity Tax Credit (AOTC) or the Lifetime Learning Credit (LLC) for those same expenses. However, since those credits start phasing out at a Modified Adjusted Gross Income (MAGI) of just $80,000 ($160,000 MFJ), most white coat investor families aren't eligible for them anyway.
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What do you think? When is it too late to bother with a 529? Did you or anybody in your family have a late start with a 529?
I recently set up 529s for my grade school aged kids. The 529 website (Utah) has you estimate the education cost in the future (let’s say $150k) and then you pick what % of that you want the account to grow to, in the next X years, until the kids are 18, to get a monthly contribution. It’s expensive! What are people choosing? I picked to fund about half their estimated education expense and figured we will make up the rest later with summer jobs, cash flow it, etc. Also didn’t want to end up with a bunch of extra money on the 529s
I don’t think it’s that expensive if your kids are going to school in Utah. Our colleges range from $4-12K in tuition here. A far more common issue here is overfunded 529s (not that that is a huge problem.)
If you put $250 a month ($3,000 a year) into the account for 18 years and it grows at 8% that’ll be $112,000 when they start school. That ought to cover $30K a year or so. The University of Utah ($12K/year) has a COA of $28K/year.
You can also pay student loans up to 10,000 in a lifetime. So in Oregon when I first graduated, I took 3000 the first year, 3000 the second year, 3000 the third year and put it in a 529 for $900 in state tax breaks and paid off a portion of my loans. While this might not be much, everything helps especially early on.
I think you missed Pennsylvania in the chart.
In Pennsylvania, the maximum deduction for 529 plan contributions is equal to the annual gift tax exclusion. In 2024, the annual gift tax exclusion is $18,000 for single filers and $36,000 for married couples filing jointly. This means that Pennsylvania residents can deduct up to $18,000 per beneficiary per from their Pennsylvania taxable income each year.
I don’t think it even needs to be to the PA 529 plan, although it is a good one.
Thanks for the info. It’s been added.
I think Missouri was missed. $8000 single or $16,000 MFJ.
Thanks for the info. It’s been added.
It looks like you missed Arizona in the chart as well. Arizona residents can deduct up to $2,000 per beneficiary for each tax year on contributions to a 529 plan if they are single or the head of a household. Married couples filing jointly can deduct up to $4,000 per beneficiary. There is no limit to the number of beneficiaries an Arizona resident can contribute to in a tax year.
Thanks for the info. It’s been added.
Hi Jim It looks like in the article you mentioned New Jersey does have a state tax break in the chart, but then mention that it doesn’t in the text of the article. NJ does offer now estate tax deduction however there is an income limit to this state tax deduction unfortunately, so a lot of white investor readers would likely be phased out for this tax break.
Thank you for the correction/clarification!
I highly recommend 529’s. I started one for each of my three children when they were small, 3-4 years old. I used a chart put out by T. Rowe Price to kinda know how much to invest. I used Utah’s, Ohio’s and Delaware’s stock based plans. I have one finishing college this year, one starting college, and one still in high school. As it stands I do not think I will need to pay anything out of pocket, all expenses, tuition, room and board, even computers, paid from the 529’s. My recommendation, start early, and keep investing no matter what, through financial crises, like 2008, or 2018, or Covid. You’ll be glad you did, not scrambling to find the money later, you just login, click and button and the money goes straight to the school.
Glad they’ve worked great for you!
Any idea when we can expect to hear more details about the 529 Roth conversion?
Anything in particular you’re wanting to know?
There is a lifetime $35,000 roll over that can be done to beneficiary’s Roth from 529. How easy or difficult is the conversion ? Does roll over has to be gradual meeting annual Roth Contribution or lumpsump 35,000 can be rolled over ?If the beneficiary is working and already has Roth max out for the year , can the lump-sump can still be rolled over ? Also is there a time limit when this conversion needs to be done ?
Should be pretty easy.
You cannot roll over more than the annual contribution amount each year. It’s either the rollover or the regular contribution, not both.
No limit, it can be done for years. But the money has to have been in a 529 for at least 15 years.
It looks like you already explained the details earlier this year (I guess I just missed it): https://www.whitecoatinvestor.com/the-529-to-roth-ira-rollover/
The Oklahoma 529 tax deduction is a maximum of $10,000 per year ($20,000 if MFJ) but it is not really per beneficiary, it is just a flat maximum regardless of how many beneficiary accounts you have. I, myself, had some confusion on this issue because the OK529 website did (at least at some point) use the words ‘per beneficiary.’ After reaching out and asking for clarification those numbers were confirmed to be flat maximums for the contributor(s), regardless of how many beneficiary accounts you have.
Currently, this is what their website says in the FAQs:
If you are an Oklahoma taxpayer, your contributions to your Oklahoma 529 account may be deducted from state taxable income. This deduction is for a maximum of $10,000 per year for a single return and $20,000 per year for a joint return. You do not have to be related to the beneficiary to take advantage of this deduction. The state tax deadline is April 15 of the following year. Carry forward larger amounts up to five years.
Thank you!
Montana is easily overlooked (unless we are considering outdoor activities), but for my case could this be added to the list as well?
I’m in Missoula. Montanans get a $6000 total limit each year for the state tax refund ($3000 per parent). Saves a couple hundred bucks with income tax. With four kids I wish it was higher, but at least it is something.
Thanks for the info. It’s been added.
Massachusetts is correctly listed in the chart documenting its tax deduction, but then is incorrectly listed in the paragraph below saying there is no tax deduction. In a prior article written a few years ago a correction was made when it listed no tax deduction for MA. I assume this somehow got carried over from that. Impossible to keep it all straight. Thanks for your hard work.
Thanks. I’ve adjusted that in the post.
The greatest tool to help us “keep it all straight” is our many wonderful readers like you. Thank you! Together we’ll get it right. Eventually.
Of course, once we get it all right, the states will then change everything.
I live in Georgia where it’s $8K state income tax deduction per beneficiary (so I can claim up to $16K/year for 2 kids) which I’m planning to max out. I’m looking where I can further invest for my children, especially for gifts from grandparents and other family members.
What are your thoughts on UTMA / UGMA accounts? I’ve opened one for my son (with a bit of seed money), but I’m realizing it may make more sense to either double-down in his 529, even if I don’t get the state income tax benefit since I’ll be able to avoid capital gains, or to invest it in my taxable accounts anyways and just transfer to him when he becomes of age.
Is there any situation where it makes sense to have a UTMA / UGMA if I would be willing to transfer the funds to him anyways? Thanks!
Kansas has a state tax deduction.
https://kansascash.ks.gov/assets/files/education_savings_FAQs_johnson.pdf
FAQ from LearningQuest:
Q: What are the tax advantages?
A: There are tax advantages under both Kansas and federal law. Earnings grow tax deferred under both
federal and Kansas law and can be withdrawn tax free for qualified higher education expenses. In addition,
Kansas taxpayers may take an annual deduction of up to $3,000 ($6,000 for married, filing jointly) from
Kansas adjusted gross income for contributions into each beneficiary’s Learning Quest, Learning Quest
Advisor, or Schwab 529 account or contributions to a 529 plan sponsored by any other state.
I can’t believe how many corrections we’ve had to do on this post. These deductions/credits change so fast. It must be a dozen or more changes in the last 2 years among the 50 states.
Another one to add to the list:
Delaware’s Fidelity 529 plan offers $1000 tax deduction for single filer up to $100k AGI and $2000 tax deduction for MFJ up to $200k AGI. The state also contributes $100 to the account if you open an account with at least a $100 contribution for a beneficiary age 5 or younger, if the account is opened by the end of this year. I believe these deductions can only be taken by Delaware residents.
https://treasurer.delaware.gov/education-savings-plan/
Thank you!
The state of Colorado implemented the following tax deduction limits a couple of years ago:
“For the 2024 tax year, the deductions will be increased to $22,700 per taxpayer, per Beneficiary for single filers, or $34,000 per tax filing, per Beneficiary for joint tax return filers.”
we started modestly when our 4 kids were infants and have been consistent each year. Now that they’re in or approaching college years, we have over $1M in 529 funds. At this magnitude, seems like a pretty powerful tax free machine, so I’m considering paying their education costs out of current cash flow to keep the 529 machine growing, with hopes that it can fund further generations of educational costs. Wondering what you thought about this Jim.
Is there any information for grand parents? I have only one grandchild and she lives in California and we live in Alabama.
Can I claim any credit?
Should I set it up in California or Alabama or anywhere? Thanks
If you’re a resident of Alabama, you only get a state tax deduction ($5000 if filing single, $10,000 MFJ) on your 529 contributions if you are using an Alabama 529 plan. The 529 can be used to pay for educational expenses out of state, so if your grandchild goes to college in California, you still won’t have to pay income taxes on any withdrawals used for qualifying education expenses. If you open a 529 under any other state’s plan, you don’t get the Alabama tax deduction up front AND any withdrawals from that plan count toward your Alabama income for state tax purposes. https://www.revenue.alabama.gov/faqs/is-the-money-from-my-florida-529-savings-plan-taxable-if-it-is-used-to-pay-for-my-sons-higher-education-expenses/
I think your Utah numbers are off. 2024 maximum allowable contribution for state income tax credit is $4,820 for married filing jointly (single is $2,410) and the max credit is 4.55% of that so $219.31 per beneficiary
https://my529.org/benefits-of-my529/tax-advantages/
Yea, two recent changes in Utah. The credit goes up with inflation each year and our tax rate dropped recently.
Can you clarify how excess contributions are taxed.
For example let’s say I contribute 100k initially and that grows to 200k. I spend 100k on education for a child and then there is 100k left in the account (the amount of my original contribution). Can I then pull out the originally contributed 100k penalty and tax free?
Good question. You’re asking if the earnings or principal are spent first or if it’s prorated. Principal can come out tax and penalty-free and earnings not used for education are fully taxable at ordinary income tax rates plus the 10% penalty.
This says pro-rata: https://www.savingforcollege.com/article/can-i-withdraw-contributions-from-a-529-plan-without-penalty#
which seems right to me. So the 529 provider presumably keeps track of basis for you and will send you a tax form showing how much of your non-qualified withdrawal is taxable.
So to answer your question, no, you can’t just pull out the principal. Withdrawals all must be pro-rated.
I have a 529 question I haven’t found online or in the forums. My child just married so would actually qualify for financial aid. However, since it’s a state school, tuition isn’t that much and the expected 529 contribution from the 529 would minimize his aid. Outside of the moral dilemma, is there any issue in changing the beneficiary of the 529 and saving and growing the 529 money for later when he goes to med school? It’s more than enough for undergrad, but nowhere close to enough for med school.
Beneficiaries can be changed. If outside the current generation there can be gift tax consequences.
There are 5 categories states fall into with 529 tax benefits:
1. No benefit
2. No state income tax
3. Tax deduction
4. Tax credit
5. Tax parity
The following article offers a nice, current resource on each state:
https://www.morningstar.com/personal-finance/how-do-your-states-529-tax-benefits-stack-up
For those living in states with no benefit, no state income tax, or tax parity – It makes sense to “shop around” for the best 529 plan (i.e. just use the Vanguard 529).
If only there were an article on this site trying to keep an up to date list of those tax benefits.
https://www.whitecoatinvestor.com/best-529-plans-reviews-ratings-and-rankings/