Posted in Triplett & Carothers on June 4, 2025

A 529 plan, operated by a state or educational institution, comes with tax advantages and potentially other incentives to make it easier to save for:

• College and other postsecondary training
• Tuition in connection with enrollment or attendance at an elementary or secondary public, private or religious school for a designated beneficiary

There are two basic types of 529 plans: prepaid tuition plans and savings plans. Each state has its own plan, and each is somewhat unique. States can offer both types of plans; however, a qualified educational institution can only offer a prepaid tuition type 529 plan.

Know the basics

Often parents, grandparents or other relatives of a child begin setting aside money in a 529 plan when the child is born, since the benefit of a 529 plan comes with the tax-free withdrawal of earnings that build up in the plan based on the contributions made over a number of years. Like other types of savings accounts, earnings are usually a function of time, so the earlier in a child’s life contributions are made, the larger the amount will be by the time the child enrolls in college or in another post-secondary educational institution.

Observation: You are not restricted to using the 529 plan of the state you live in. While your state may offer incentives to win your business, the market is competitive, and another state’s plan may be more aligned with your financial needs.

Whether setting up a 529 plan is the right investment for you to make depends on many factors. These plans are not for everyone and are also not the only option available for paying for college. A 529 plan is an investment decision, which means both the benefits and drawbacks must be considered, along with alternative ways of accomplishing similar financial goals.

Because there are many investment options available and many independent sources of information on 529 plans, you should consider consulting a trusted tax professional or financial planner before embarking on setting up a 529 plan.

Tax advantages of a typical 529 plan

The earnings on amounts invested in a 529 plan are not subject to federal tax and are generally not subject to state tax when used for a designated beneficiary’s qualified education expenses, such as tuition, fees, books, and room and board at an eligible education institution and/or tuition at elementary or secondary schools.

For federal tax purposes, contributions to a 529 plan are not deductible; thus, contributions to the plan are made with after-tax dollars. However, some states allow their residents to deduct a part or all of the contributions to a qualified tax plan from their state income taxes if the contributions are made to an in-state plan.

Generally, with respect to any QTP distribution, no amount is includible in the gross income of a designated beneficiary of such QTP, or a contributor to such program.

Who can set up a 529 plan?

Anyone can set up a 529 plan. There are no limitations on the amount of income that either party to the plan must have. Nor are there any requirements on the type of relationship that must exist between a contributor to the plan and the beneficiary. Whoever purchases the 529 plan is the custodian and controls the funds until they are withdrawn.

Limits on contributions

Contributions to a 529 plan cannot exceed the amount necessary to provide for the qualified education expenses of the beneficiary. If you contribute to a 529 plan, however, there may be gift tax consequences if your contributions, plus any other gifts, to a particular beneficiary exceeds the gift tax exemption for the year ($19,000 during 2025).

However, there is a special rule that applies to contributions to 529 plans if certain conditions are met. Under this rule, if for 2025 you contribute more than $19,000 to a 529 plan on behalf of any one person, you may elect to treat up to $95,000 of the contribution for that person as if you had made it ratably over a five-year period. The election allows you to apply the annual gift tax exclusion to a portion of the contribution in each of the five years, beginning in 2025. You can make this election for as many separate people as you made QTP contributions.

Making this election requires special calculations and reporting on the donor’s gift tax returns (i.e., Forms 709) for the five-year period over which the contributions are spread. It’s best to involve a tax professional who has gift tax experience if you plan on making such contributions to a 529 plan.

How to handle leftover 529 contributions

By the time a child goes to college, a number of things may have happened such that the 529 plan has money left over once a child finishes his or her education. For example, the child may have been awarded scholarships, may have received an inheritance or may have chosen a school with a more moderate tuition cost than expected. Previously, dealing with leftover amounts in a 529 plan could subject the owner or beneficiary of the account to a 10% tax penalty for nonqualified withdrawals. However, new rules became effective beginning in 2024 upon the enactment of the Consolidated Appropriations Act of 2023.

Under these new provisions, 529 plan owners or beneficiaries can do a tax- and penalty-free rollover of the amounts in a 529 plan into a beneficiary-owned Roth IRA. However, the maximum amount that may be rolled over is limited to the Roth IRA annual contribution limits set by the IRS ($7,000 for 2024 and 2025; $8,000 for age 50 or older). There is also a $35,000 lifetime limit on the amount that may be rolled over.

Example: On June 1, 2025, John is 25 years old and the beneficiary of a 529 plan. He has finished college and has $21,000 left in his 529 plan. He does not intend to further his education and would prefer to move the $21,000 to a Roth IRA and begin saving for his retirement. In 2025, John can transfer $7,000 from his 529 plan to a Roth IRA set up in his name. John has $14,000 remaining in his 529 plan and can transfer the maximum allowable into his Roth IRA in 2026 and 2027.

In setting up a Roth IRA plan, a number of decisions must be made as to the types of investments the plan should use. A financial professional can help sort out the types of investments that may be best based on an individual’s goals.

Reach out to Roz Carothers and her team at Triplett & Carothers to learn more.

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