With college costs climbing every year, saving for your child’s future education might feel like an uphill goal. Enter the 529 plan: one of the smartest investment accounts allowed to accomplish this goal. This tax-advantaged savings plan lets you open an investment account where your money can grow tax-free—think a decade or more of compounding interest working in your favor. Withdrawals are also tax-free when used for qualified expenses, like tuition, books, or room and board, for the beneficiary—typically your child. 529 plans are sponsored by states, usually available to all, giving you the freedom to pick the one that best matches your family’s goals, no matter where you live.
Everything You Need To Know
529 Plan
Education Savings Plans
Contributions
Contributions to a 529 plan must be made in cash—such as checks, electronic transfers, or similar methods—not in the form of assets like stocks or property. A standout feature of 529 plans is their accessibility: there are no income restrictions, so anyone can contribute, regardless of their income. Each state sets its own contribution limits, which are typically generous—often exceeding $300,000 per beneficiary over the lifetime of the account. This makes 529 plans a versatile option for families across all income levels who want to build a robust education fund for a beneficiary, usually your child or grand-child.
Limitations
Unlike some educational savings vehicles, 529 plans don’t impose an annual contribution cap. Instead, the IRS classifies contributions to a 529 account as gifts, which are governed by gift tax rules rather than a yearly fixed limit. While lifetime account contribution limits and tax considerations apply, these rarely prevent substantial contributions—even within a single year—if you wish.
Total Contribution Limit (aggregate limit)
Each state’s 529 plan establishes an aggregate limit—the maximum total contributions allowed for a beneficiary across all accounts in that plan. For example, if both you and a grandparent open a 529 account for the same child in the same state’s plan, both accounts count toward this contribution cap, regardless of ownership. Excluding earnings, this contribution cap generally ranges from $235,000 to $575,000 depending on the state. Once this limit is reached, no further contributions are allowed, but the account can still grow through investment returns.
Annual Gift Tax Exclusion
The IRS treats 529 contributions as gifts to the beneficiary. However, the annual gift tax exclusion typically prevents most contributors from worrying about gift tax. For example, in 2025, you can contribute up to $19,000 per beneficiary ($38,000 for married couples filing jointly) into a 529 account without filing a gift tax return. As long as you stay under this threshold, no tax paperwork is required, unless additional gifts are made to the same beneficiary. The below tabs show the annual gift tax exclusions for the past several years.
↳ Tax Year 2025
| Annual Gift Tax Exclusion Per Beneficiary |
|---|
| $19,000 per person ($38,000 for married) |
↳ Tax Year 2024
| Annual Gift Tax Exclusion Per Beneficiary |
|---|
| $18,000 per person ($36,000 for married) |
Lifetime Gift Tax Exemption
If your contribution exceeds the annual gift tax exclusion amount for the tax year, you’ll need to file a gift tax return (Form 709—one per spouse if married), but you likely won’t owe any gift tax. The excess contribution simply reduces your lifetime gift tax exemption. You’ll only pay gift tax after you’ve used up this lifetime exemption, making large contributions feasible for most people. The lifetime gift tax exemption amount for the past several years are listing in the below tabs.
↳ Tax Year 2025
| Lifetime Gift Tax Exemption |
|---|
| $13,990,000 per person |
↳ Tax Year 2024
| Lifetime Gift Tax Exemption |
|---|
| $13,610,000 per person |
Generation-skipping (GST) Exemption
If you’re a grandparent or great-grandparent (two or more generations above the beneficiary or at least 37.5 years older), contributions exceeding the annual gift tax exclusion amount for a tax year could trigger the Generation-Skipping Transfer (GST) tax, in addition to regular gift tax rules. You’ll still file Form 709 (already required for exceeding the annual gift tax exclusion), but the GST tax will likely not apply. The excess contribution will count against your GST exemption. Only after depleting this lifetime cushion would GST tax be triggered, making significant contributions across generations still viable. The GST exemption amount is listed in the below tabs for the past several years.
↳ Tax Year 2025
| GST Exemption |
|---|
| $13,990,000 per person |
↳ Tax Year 2024
| GST Exemption |
|---|
| $13,610,000 per person |
5-year Lump Sum Contribution (superfunding)
If you’re seeking to maximize a 529 plan contribution without incurring gift tax, the 5-year lump sum strategy—often called superfunding—offers an effective solution. This approach allows you to make a single contribution of up to five times the annual gift tax exclusion and spread it evenly across five years. In 2025, with the exclusion at $19,000, you can contribute up to $95,000 ($190,000 for married couples filing jointly) without incurring gift tax. The IRS treats this as $19,000 per year ($38,000 for couples) over the five-year period, which keeps it within the annual exclusion. To use this strategy, you must file Form 709 in the year of the contribution to elect the 5-year averaging; no further filings are required in subsequent years unless you make additional reportable gifts to the same beneficiary.
Key Consideration
By committing to this approach, you fully use your annual exclusion for that beneficiary for five years. If you max out at $95,000 (in 2025) and later make additional gifts—such as cash or further 529 contributions—any amount exceeding $19,000 (in 2025) in a given year will require a new Form 709 filing and count toward your lifetime gift tax exemption, which is set at $13,990,000 in 2025.
Gifts From Family and Friends
A gift-giver—whether a grandparent, aunt, or friend—can support a beneficiary’s education through a 529 plan in two primary ways. They may open a new account for the beneficiary, as there’s no restriction on the number of 529 accounts a single beneficiary can have, as long as each is owned by a different individual. Note, however, that the state’s aggregate contribution limit, which varies by plan, applies across all accounts for that beneficiary, regardless of who owns them. Alternatively, they can contribute to an existing account, such as one set up by the child’s parents. For example, grandparents could make a contribution to a parent-owned account. Many state plans facilitate such contributions with user-friendly online portals or gifting options, simplifying the process for family and friends.
Is it better for the parent or grandparent to be the owner of the 529 account?
Determining whether a parent or grandparent should own a 529 account is complex, as federal and state rules governing these plans can evolve over time—particularly over the 5, 10, or 15 years before the beneficiary begins using the funds for qualified education expenses. While long-term planning is inherently uncertain, current regulations and trends can provide guidance.
The updated FAFSA (Free Application for Federal Student Aid), effective for the 2024-2025 academic year, significantly impacts this decision. Previously, distributions from grandparent-owned 529 plans were reported as untaxed student income on the FAFSA, potentially reducing aid eligibility by up to 50% of the distributed amount. Now, students are no longer required to report cash support—including withdrawals from grandparent-owned 529 accounts—making these distributions invisible in the FAFSA process. This change removes the financial aid penalty that was previously associated with grandparent ownership.
In contrast, parent-owned 529 accounts are reported as parental assets on the FAFSA, with their value assessed at a maximum rate of 5.64% when calculating the Student Aid Index (SAI). This could slightly reduce aid eligibility. Under the old FAFSA rules, parent ownership was often preferred because it had a lesser impact on aid—5.64% of assets versus up to 50% of distributions. With the new FAFSA changes, grandparent-owned accounts may now offer a financial aid advantage.
However, complications remain. Many private colleges use the CSS Profile, which may still consider grandparent-owned 529 accounts or distributions, depending on the school’s policies. Additionally, state-specific tax deductions or credits for 529 contributions—often only available to account owners—could make parent ownership more advantageous in certain states. These variables, combined with the potential for future rule changes, make it difficult to declare a definitive “best” option. Families should weigh financial aid goals, tax benefits, and control preferences when deciding who should own the 529 account.
Investments
A 529 plan typically offers a range of investment options, including stock mutual funds, bond funds, and money market funds, allowing you to tailor your portfolio to your risk tolerance and timeline. Many state plans also feature target-date funds—sometimes called age-based portfolios—which automatically shift from aggressive investments (heavily weighted toward stocks) to conservative ones (favoring bonds or cash equivalents) as the beneficiary nears college age, reducing risk over time.
Because 529 plans are administered by individual states, investment choices and associated fees vary significantly. Some plans offer low-cost, diversified options, while others may have higher fees or limited selections. For guidance on top-performing plans, please see our recommended 529 plan page.
Investment flexibility has limits: you can generally reallocate existing assets among the plan’s options only twice per calendar year, a restriction set by federal tax rules to prevent frequent trading. However, most plans allow you to adjust the investment options for future contributions at any time, giving you ongoing control as your strategy or market conditions evolve. Be sure to review your specific plan’s rules, as terms and fees can differ.
Distributions
Overview
Withdrawals from a 529 plan, known as distributions, are tax-free and penalty-free when used for qualified education expenses (QEE)—such as tuition, books, or room and board—or when they meet specific IRS exceptions or rules. Contributions to 529 plans are made with after-tax dollars, receiving no federal tax deduction, so the portion of a distribution representing contributions (the “basis”) can always be withdrawn without tax or penalty. Earnings, however, are subject to federal income tax and a 10% penalty if the distribution isn’t qualified. Notably, distributions are disbursed on a pro-rata basis, meaning each withdrawal reflects a proportional blend of contributions and earnings, not one component alone.
Very Important To Keep Good Records
Accurate records are essential to ensure distributions align with QEE within the same calendar year (the tax year, not the academic year). Mismatched timing can turn a withdrawal into a non-qualified distribution, triggering taxes and penalties. For instance, taking a distribution in January 2025 to cover a December 2024 expense would not qualify, as the expense falls in a prior tax year.
You can opt to pay QEE directly from your 529 account to the educational institution or withdraw funds to your personal bank account for reimbursement after paying out-of-pocket. We generally recommend direct payments to the school whenever feasible, as this simplifies tracking and reduces the risk of timing errors. If choosing reimbursement, ensure the distribution occurs in the same tax year as the expense and retain documentation, such as receipts and bank statements, to substantiate the withdrawal.
Qualified Distributions
Qualified distributions from a 529 plan refer to withdrawals that are exempt from federal income taxes and the 10% penalty on earnings, as long as the funds are used for approved purposes under IRS guidelines. These distributions provide significant tax advantages for education savings, but it’s essential to understand the eligible expenses and limitations to avoid unintended tax consequences. Below list the distribution options to avoid federal income tax along with the 10% penalty on earnings:
↳ Qualified Education Expenses (QEE)
Funds from a 529 plan can be withdrawn tax-free and penalty-free when used for qualified education expenses (QEE), which vary by educational level. Below are the key categories and limitations.
Kindergarten Through 12th Grade
For elementary through high school, up to $10,000 per beneficiary per calendar year can be used for tuition at public, private, or religious schools. This limit applies only to tuition—expenses like school supplies, books, or room and board do not qualify for K-12 distributions under IRS rules.
College or Other Postsecondary Training Institutions
For college, university, or other eligible postsecondary programs (e.g., vocational or trade schools), 529 funds can cover a broader range of QEE, including:
- Tuition and mandatory fees
- Room and board (if the student is enrolled at least half-time)
- Books, supplies, and equipment required for enrollment
- Computers, software, and internet access (if primarily used for education)
To determine the penalty & tax-free withdrawal amount, you must calculate the Adjusted Qualified Education Expenses (AQEE) for the year, which adjusts gross expenses for tax-free aid and credits. The formula is:
- Total Qualifying Cost: Add up all tuition, fees, room and board, supplies, text books and computer cost.
- Subtract Tax-Free Assistance: Deduct any amounts covered by tax-free educational benefits, such as Pell Grants, tax-free scholarships, veterans’ assistance, employer-provided education programs, or tuition discounts.
- Subtract Tax Credits: Deduct expenses used to claim the American Opportunity Tax Credit (AOTC) or Lifetime Learning Credit (LLC).
EXAMPLE: If your child’s college costs are $20,000 (tuition, fees, room, and books), with a $5,000 tax-free scholarship and $4,000 claimed for the AOTC, the AQEE is $20,000 – $5,000 – $4,000 = $11,000. You can withdraw $11,000 penalty and tax-free; any excess risks tax and a 10% penalty on earnings.
Room & Board Rules
For 529 plan distributions to cover room and board tax-free, specific conditions must be met:
- Enrollment Requirement: The beneficiary must be enrolled at least half-time in an eligible postsecondary institution, as defined by the school’s accreditation for federal financial aid
- Cost Limits: Room and board expenses are capped at the amount recognized by the institution as part of its Cost of Attendance (COA) for federal aid purposes.
- To confirm the allowable amount, check the school’s website under its financial aid or cost of attendance section, or contact the financial aid office directly. Documentation of these costs is critical for ensuring tax-free withdrawals.
Expenses That Don't Qualify
- Insurance payments
- Sports expenses
- Monthly health club dues
- College application and testing fees
- Transportation and travel cost
- Smartphones
- Electronics such as TVs
↳ 529-To-Roth IRA Rollover
The IRS permits 529 plan funds to be rolled over into a beneficiary’s Roth IRA as a tax-free and penalty-free qualified distribution, provided specific conditions are met. These conditions include:
- Account Age: The 529 account must have been maintained for the beneficiary for at least 15 years before the rollover
- Contribution Timing: Contributions made to the 529 plan within the five years prior to the rollover date, along with their associated earnings, are ineligible for a tax-free transfer.
- Annual Limit: The rollover amount cannot exceed the beneficiary’s Roth IRA contribution limit for that year (e.g., $7,000 in 2025 for those under 50), reduced by any direct Roth IRA contributions the beneficiary has already made that year.
- Earned Income: The beneficiary must have earned income at least equal to the rollover amount in the year of the transfer.
- Lifetime Cap: The total amount rolled over from all 529 accounts to a beneficiary’s Roth IRAs cannot exceed $35,000 over their lifetime, regardless of the number of rollovers or accounts involved.
- Direct Transfer: The rollover must be executed as a trustee-to-trustee transfer from the 529 plan custodian directly to the Roth IRA custodian—no personal withdrawal is permitted.
This option offers a strategic way to repurpose excess 529 funds for the beneficiary’s retirement, avoiding the income tax and 10% penalty that would apply to non-qualified distributions on the earnings portion. It’s particularly valuable when education savings outpace college costs, providing long-term financial flexibility.
Is the beneficiary subject to the Roth IRA income phase-out limits?
No, the beneficiary of a 529-to-Roth IRA rollover is not subject to the Roth IRA income limits that typically apply to direct Roth IRA contributions, but the beneficiary must have earned income equal to or greater than the rollover amount.
After rolling over the 529 funds to the beneficiary's Roth IRA, does the five year rule still apply to their Roth IRA withdrawals?
The funds transferred from the 529 to the Roth IRA (e.g., $7,000 in 2025) are considered a Roth IRA contribution for that year. Per Roth rules, contributions can be withdrawn tax-free and penalty-free at any time, regardless of the five-year rule. No waiting period applies to this portion. Any growth in the Roth IRA after the rollover (e.g., investment gains) is subject to the five-year rule for earnings.
↳ Student Loan Repayment
Excess 529 plan funds can be withdrawn tax-free and penalty-free to repay qualified student loans for the beneficiary or their siblings, subject to a lifetime limit of $10,000 per individual. Qualified student loans include federal loans (e.g., Stafford, PLUS) and most private loans that meet IRS criteria (e.g., used for qualified education expenses at an eligible institution). Eligible siblings are defined as brothers, sisters, stepbrothers, and stepsisters. This $10,000 cap applies per borrower across all 529 plans—meaning the beneficiary and each sibling are each limited to $10,000 total from all accounts, not per account or per plan.
Additionally, 529 funds can be used to repay student loans held by a parent, such as a Parent PLUS Loan, but this requires a key step: the account owner must first change the beneficiary to the parent (e.g., from child to themselves). The same $10,000 lifetime limit per borrower applies, and this is separate from the beneficiary’s or siblings’ limits. For example, a 529 could repay $10,000 for the original beneficiary (child), $10,000 for a sibling, and—after a beneficiary change—$10,000 for the parent, totaling $30,000 across three individuals, assuming sufficient funds.
Documentation, such as loan statements showing the borrower and payment records, is critical to ensure these distributions qualify under IRS rules.
Non-qualified Distribution
You can withdraw funds from a 529 plan at any time, but if the distribution isn’t used for qualified education expenses (QEE) or doesn’t qualify under an IRS-approved exception, it’s deemed non-qualified. The earnings portion of such a distribution is subject to federal income tax and plus a 10% penalty (unless an exception applies). The basis portion (contributions) remains tax- and penalty-free, as it’s funded with after-tax dollars. In addition, distributions are withdrawn on a pro-rata basis—blending contributions (basis) and earnings.
Exception to the 10% Penalty
You can avoid the 10% penalty but not ordinary income tax on a non-qualified distributions if the distribution is made because:
- Death or Disability: The penalty is waived if the beneficiary dies or becomes disabled
- Tax-Free Scholarship: If the beneficiary receives a tax-free scholarship (e.g., a merit award or Pell Grant), the penalty is avoided on withdrawals up to the scholarship amount, though earnings remain taxable.
- Employer-Provided Assistance: Educational assistance from a qualifying employer program exempts the penalty on withdrawals matching that assistance amount.
- U.S. Military Academy Attendance: Enrollment at a U.S. military academy (e.g., West Point, Naval Academy) waives the penalty on distributions up to the cost of attendance, as the education is typically fully funded.
- Use for Education Tax Credits: If funds are withdrawn to cover expenses used to claim the American Opportunity Tax Credit (AOTC) or Lifetime Learning Credit (LLC), the penalty is waived on that portion, though coordination with adjusted qualified education expenses (AQEE) is required to avoid double-dipping.
The Pro-Rata Formula
Since distributions are withdrawn on a pro-rata basis—blending contributions (basis) and earnings—you’ll need to calculate the taxable and penalized amounts using the following steps when taking a non-qualified distribution.
- Basis Portion = (Total Contributions / Value of 529 Plan Account) * Amount of Distribution
- Earnings Portion = Amount of Distribution – Basis Portion
After you calculate the earning portion of the distribution, you must calculate the reportable earnings subject to ordinary income tax and a 10% penalty (if exception does not apply).
- Qualified earnings = (Adjusted Qualified Education Expenses / total 529 plan distributions) * earning portion
- Reportable income (subject to ordinary income and possible 10% penalty if exception does not apply) = Earning portion – qualified earnings
Pro-rata Example
You Have The Following Scenario
- You made $150,000 contributions to the 529 account
- The total value of the 529 plan is $200,000
- You took a distribution from the 529 plan for $10,000
- You later calculated that the adjusted qualified education expense only came out to $7,000
How To Do The Calculation
- ($150,000/$200,000)*10,000 = $7,500 (basis portion)
- $10,000 – $7,500 = $2,500 (earning portion)
- ($7,000/$10,000)*$2,500 = $1,750 (qualified earning portion)
- $2,500-$1,750 = $750 (reportable taxable income & subject to 10% penalty)
Transferability
Changing Account Beneficiary (529 Transfer)
A 529 transfer involves changing the beneficiary of an existing 529 plan. Each account can have only one beneficiary at a time, and this individual need not be the original contributor. You may change the beneficiary an unlimited number of times without income tax or penalty, provided the new beneficiary is a “family member” of the current beneficiary, as defined by the IRS. Qualifying family members include:
- Spouse
- Son, daughter, stepchild, foster child, adopted child, or a descendant
- Son-in-law, daughter-in-law
- Siblings or step-siblings
- First cousin or their spouse
- Brother-in-law, sister-in-law
- Father-in-law, mother-in-law
- Father or mother or ancestor of either stepmother, stepfather
- Aunt, uncle, or their spouse
- Niece, nephew, or their spouse
If the new beneficiary is not a family member of the current beneficiary, the change is treated as a non-qualified distribution. The earnings portion of the transferred amount will incur ordinary income tax and a 10% penalty, calculated pro-rata (see “Non-Qualified Distributions” section). The process to change a beneficiary is typically straightforward. Contact your 529 plan administrator to obtain and complete the required forms, providing details such as the new beneficiary’s name, Social Security number, and relationship to the current beneficiary.
Gift Tax Consequences
Changing a 529 plan beneficiary to a family member incurs no income tax or 10% penalty, provided the new beneficiary qualifies under IRS family member rules. However, gift tax consequences may arise depending on the generational relationship between the current and new beneficiaries:
- Gift Tax if Same or Higher Generation: If the new beneficiary is in the same generation (e.g., sibling) or a higher generation (e.g., parent) relative to the current beneficiary, the transfer is not considered a taxable gift, regardless of the account’s value.
- Gift Tax if Lower Generation: If the new beneficiary is one or more generations below the current beneficiary (e.g., parent to child, or child to grandchild), the IRS treats the account’s value at the time of transfer as a gift from the current beneficiary to the new one. A gift tax return (Form 709) is required if this value exceeds the annual gift tax exclusion—$19,000 per recipient in 2025 ($38,000 for married couples splitting gifts).
Who Files the Gift Tax Return?
The current beneficiary is generally considered the donor and thus responsible for filing Form 709 when a reportable gift occurs due to a beneficiary change to a lower generation. This stems from the IRS treating 529 contributions as completed gifts to the beneficiary at the time of contribution; a subsequent change transfers that “ownership” to the new beneficiary, with the current beneficiary as the gifter.
This contrasts with the account owner’s role, who controls the change but isn’t deemed the donor unless they’re also the beneficiary (e.g., a parent-owner switches from themselves to their child).
Example of Gift Tax Consequence
Tyler is the beneficiary of a 529 account established by his father years ago, now valued at $100,000. With Tyler’s college years complete, his father, the account owner, changes the beneficiary to Tyler’s daughter, Zoey, transferring the entire account. Since Zoey is one generation below Tyler (parent to child), the IRS treats this $100,000 transfer as a gift from Tyler to Zoey, even though Tyler, as the beneficiary, has no control over the account or the decision to change beneficiaries.
Because the account’s value exceeds the 2025 annual gift tax exclusion of $19,000, Tyler—the current beneficiary and deemed donor—must file Form 709 to report the gift. After applying the $19,000 exclusion, the remaining $81,000 reduces Tyler’s lifetime gift tax exemption ($13,990,000 in 2025), assuming no other gifts to Zoey that year. Tyler can’t elect the 5-year super-funding, as this isn’t a contribution.
529 Plan Rollover
A 529 plan rollover involves transferring funds from one state’s 529 plan to another state’s plan for the same beneficiary. Since 529 plans are administered at the state level, they vary in investment options, fees, and performance—not all are created equal. You might opt for a rollover to access better investment choices, lower costs, or to consolidate multiple 529 accounts for the same beneficiary into a single plan, simplifying management. However, if you claimed a state income tax deduction or credit for contributions to the original plan, rolling over to another state’s plan may trigger a “clawback” by your state, requiring you to repay the tax benefit, depending on state rules.
Rollovers Are Subject To A Key Limitation
Only one tax-free rollover per beneficiary is permitted within a 12-month period, regardless of who initiates it (e.g., parents, grandparents). This 12-month window starts from the date of the previous rollover. A second rollover within that period is treated as a non-qualified distribution, subjecting the earnings portion to federal income tax and a 10% penalty, unless an exception applies. To avoid this, confirm with all account owners whether a rollover has occurred for the beneficiary in the past 12 months before proceeding. Contact your current and receiving plan administrators to initiate the process, typically via a direct trustee-to-trustee transfer.
Changing Account Ownership
The account owner controls a 529 plan, including the ability to change the beneficiary and direct distributions, even though the funds are legally held for the beneficiary’s benefit. While uncommon, the owner and beneficiary can be the same person (e.g., a parent saving for their own education). To ensure continuity, most 529 plans allow the owner to designate a successor owner—someone to assume control upon the owner’s death. Naming a primary successor is a critical step to maintain account management.
Many 529 plans also permit a voluntary change of ownership during the owner’s lifetime, transferring control to another individual for the same beneficiary. This isn’t a standard rollover (like moving between state plans) but a reassignment of account authority. Policies vary, so consult your plan administrator to confirm eligibility and ensure the change isn’t misclassified as a distribution. If mishandled, it could be treated as a non-qualified distribution, subjecting earnings to income tax and a 10% penalty. When allowed, the new owner need not be a family member of the original owner, and the transfer typically incurs no federal income tax or penalty. However, if the original owner claimed state tax deductions or credits, some states may impose a recapture tax—check your state’s rules.
Unlike 529 plan rollovers between states, which are limited to once per 12-month period per beneficiary, ownership changes generally do not fall under this restriction. Most plans treat them as administrative updates, not taxable events. However, you should always verify with your administrator to avoid unintended tax consequences, particularly if state tax deductions or credits were claimed for contributions to the original plan.
FAQs
What happens if my beneficiary doesn't attend college or I have money left over in the account?
If your beneficiary doesn’t attend college or you have funds remaining after their education, several strategies can maximize the account’s value. Below are five options:
1. Retain for Future Education Needs – If the beneficiary has completed their primary education (e.g., college), you can keep the funds in the 529 plan for potential future pursuits, such as graduate school, medical school, or professional training. The account continues to grow tax-free until needed.
2.Change the Beneficiary – You can transfer the account to another qualifying family member to cover their education expenses, such as a sibling or cousin. Alternatively, retain the funds in the account—allowing tax-free growth—and later designate a grandchild or other descendant as the beneficiary.
3.Rollover to a Roth IRA –Excess funds can be rolled over to the beneficiary’s Roth IRA to kickstart their retirement savings, subject to conditions (see “529-to-Roth IRA Rollover”).
4.Pay down a family members student loan – You can use up to $10,000 of 529 funds to repay qualified student loans for the beneficiary or their siblings.
5.Take it out as a non-qualified distribution – If you need the funds for other purposes, you can withdraw them as a non-qualified distribution. Withdrawals are pro-rated between contributions (basis), which are tax- and penalty-free, and earnings, which are subject to ordinary income tax and a 10% penalty unless an exception applies
What if the beneficiary earns a scholarship?
If your beneficiary receives a tax-free scholarship (e.g., a merit award or Pell Grant), you can withdraw funds from the 529 plan up to the scholarship amount without incurring the 10% penalty, even if the funds aren’t used for qualified education expenses (QEE). However, the earnings portion of the withdrawal remains subject to federal income tax, as this is considered a non-qualified distribution for tax purposes. The basis portion (contributions) is always tax- and penalty-free.
How does a 529 account affect a beneficiary's student aid?
A 529 account’s effect on a beneficiary’s financial aid depends on the type of aid and who owns the account. Here’s how it breaks down:
- Merit-Based Aid
- Merit-based scholarships, awarded for academic, athletic, or other achievements rather than financial need, are unaffected by a 529 account. The account’s existence, value, or ownership (parent, grandparent, or otherwise) has no bearing on eligibility for these awards.
- Need-Based Aid (FAFSA)
- For need-based federal aid, calculated via the Free Application for Federal Student Aid (FAFSA), a 529 account’s impact hinges on ownership:
- Parent-Owned 529 Accounts: These are reported as parental assets on the FAFSA and factored into the Student Aid Index (SAI), which replaced the Expected Family Contribution (EFC) starting with the 2024-2025 cycle. Up to 5.64% of the account’s value is assessed, potentially reducing aid eligibility.
- Example: A parent-owned 529 worth $20,000 could lower the student’s aid by $1,128 ($20,000 × 5.64%), assuming no other asset protections apply (e.g., asset protection allowance).
- Grandparent-Owned 529 Accounts: Under the updated FAFSA (effective 2024-2025), these are not reported as assets, nor are distributions counted as student income—a shift from prior rules where withdrawals reduced aid by up to 50%. This makes grandparent-owned 529s more aid-friendly for federal purposes.
- Parent-Owned 529 Accounts: These are reported as parental assets on the FAFSA and factored into the Student Aid Index (SAI), which replaced the Expected Family Contribution (EFC) starting with the 2024-2025 cycle. Up to 5.64% of the account’s value is assessed, potentially reducing aid eligibility.
- For need-based federal aid, calculated via the Free Application for Federal Student Aid (FAFSA), a 529 account’s impact hinges on ownership:
CSS Profile Considerations – Some private colleges and scholarship programs use the CSS Profile, which may require reporting grandparent-owned 529 accounts as assets or treat distributions as untaxed income, depending on the institution’s policy. This can increase the student’s expected contribution, potentially reducing aid more significantly than under FAFSA rules. Confirm with each school’s financial aid office.
Which colleges are available?
You can search eligible 529 educational institutions at the Federal Student Aid (FAFSA) website.
What is a 1099-Q and why did I receive one?
Form 1099-Q, “Payments from Qualified Education Programs,” is an IRS tax form issued by a 529 plan administrator to report distributions made from the account during the tax year. It identifies the recipient, the total distribution amount, and the earnings portion, which may be taxable if the withdrawal is non-qualified. You received a Form 1099-Q because you were designated as the recipient of a 529 distribution, determined as follows:
- Beneficiary as Recipient: The beneficiary receives Form 1099-Q if the distribution was paid directly to them, to an eligible educational institution on their behalf (e.g., for tuition), or to a student loan provider for their qualified loans.
- Account Owner as Recipient: The account owner receives Form 1099-Q for all other distributions, such as those paid to their personal bank account or not directed to the beneficiary or educational entity.
How can a 529 be used in estate planning?
The funds contributed to a 529 account are considered gifts at the time of contribution. Thus, it removes a portion of your estate (and future growth) from your taxable estate, while still maintaining control of the account. It is a unique way to plan for future generations and use as a tool for estate planning purposes.