As a Certified Financial Planner®, I firmly believe that if your primary goal is to fund your children’s or grandchildren’s education, a 529 college savings plan is the best option available. However, I’ve encountered many clients who worry about potential drawbacks, such as penalties, fees, or financial aid impacts. These concerns are often overblown or misunderstood, which is why in this article, we’ll bust some common myths and highlight the real benefits of a 529 plan.
Introduction: What Is a 529 Plan?
A 529 college savings plan is a tax-advantaged investment account designed to help families save for future education expenses. The beauty of the 529 plan lies in its flexibility, tax-free growth, and potential estate planning benefits. Whether you’re saving for your children or grandchildren, a 529 plan offers unparalleled benefits for funding education.
Myth #1: High Taxes and Penalties if Not Used for College
One of the most common misconceptions is that unused 529 funds will result in high taxes and penalties. In reality, the penalty only applies to the earnings (not the contributions), and it is just 10%. Plus, the tax and penalty do not apply if the funds are used for other qualified education expenses or if the beneficiary earns a scholarship. This misunderstanding deters many, but the actual risks are manageable. Even if not used for college, the funds still benefited from years of tax-deferred growth. A new option to rollover excess funds to a Roth IRA can help jumpstart your child or grandchild’s retirement which I cover in further detail below.
Myth #2: 529 Plans Hurt Financial Aid Eligibility
Another frequent worry is that 529 plans negatively impact financial aid. The truth is, a 529 plan owned by a parent is assessed at a maximum rate of 5.64% in the Expected Family Contribution (EFC) calculation, which is much lower than assets held directly by the student. The small impact on financial aid is far outweighed by the long-term savings benefits.
The benefits of setting up a 529; Ease of Setup, Management, and Systematic Investments
Setting up a 529 plan is straightforward and hassle-free. Most plans offer age-based investment options that automatically adjust the asset allocation based on the beneficiary’s age, reducing risk as they approach college age. This makes managing the account simple for busy parents and grandparents.
MORE FOR YOU
In addition, 529 plans allow you to set up automatic, systematic investments, which means you can schedule regular contributions from your bank account directly into the plan. Whether it’s monthly, quarterly, or whatever schedule works best for you, these automatic contributions ensure consistent growth of the account without requiring ongoing manual effort. This feature is especially helpful for busy individuals who want to stay on track with their education savings goals without needing to remember to make periodic contributions.
By combining these easy-to-manage investment options with automatic deposits, growing your 529 account becomes both hands-off and highly efficient.
Tax-Free Growth: The Real Advantage
Unlike a UTMA or a traditional savings account, where you pay taxes on interest or gains annually, the funds in a 529 plan grow tax-free. For affluent individuals, this tax savings over the years can be substantial, especially as college tuition continues to skyrocket. A 529 plan allows you to compound your investment, untaxed, for decades, providing significant growth potential.
Retained Control vs. Custodial Accounts
One of the key advantages of a 529 plan over a custodial UTMA/UGMA account is the control it offers to the account owner. With a 529 plan, the account owner retains full control of the funds, even after the beneficiary reaches adulthood. This means you can decide when and how the funds are used, ensuring they are spent on education or other qualified expenses. In contrast, assets in a UTMA or UGMA account become the property of the child once they reach the age of majority, at which point they can use the funds for any purpose, regardless of your intentions.
Estate Planning Benefits: Out of Your Estate and Maximizing Gifting
529 plans also offer significant estate planning advantages. Contributions to a 529 plan are considered gifts, meaning they are removed from your taxable estate. High-net-worth individuals can also take advantage of the five-year gift-forwarding provision, allowing them to contribute up to five years’ worth of the annual gift tax exclusion in a single year (currently $17,000 per year, or $85,000 per beneficiary). This is a powerful way to pass on wealth tax-efficiently.
New Flexibility: Rolling Over Excess Funds to a Roth IRA
A significant recent change has added even more flexibility to 529 plans: starting in 2024, you can roll over excess funds from a 529 plan to a Roth IRA for the same beneficiary. This option eliminates one of the biggest concerns—what to do if the funds are not needed for education expenses. Rollovers are subject to annual Roth IRA contribution limits, and there is a lifetime limit of $35,000, but this new provision allows families to repurpose unused education savings for long-term retirement benefits. It’s a powerful new tool that reduces the worry about overfunding a 529 plan.
Conclusion
A 529 plan offers a combination of tax advantages, estate planning benefits, and flexible investment options that make it an unbeatable tool for funding education. Misconceptions about penalties and financial aid often deter people from using them, but the reality is far more beneficial than most realize. If education is a priority for your family, a 529 plan should be, too.
James A. Hofmann, MBA, CRPC®, CFP®
Senior Financial Advisor
Managing Director – Investments
Wells Fargo Advisors
Investment and Insurance Products are:
*Not Insured by the FDIC or Any Federal Government Agency
*Not a Deposit or Other Obligation of, or Guaranteed by, the Bank or Any Bank Affiliate
*Subject to Investment Risks, Including Possible Loss of the Principal Amount Invested
This publication is designed to provide accurate and authoritative information regarding the subject matter covered. It is made available with the understanding that Wells Fargo and Company and its Affiliates do not provide tax or legal advice. This communication cannot be relied upon to avoid tax penalties. Please consult your tax and legal advisors to determine how this information may apply to your own situation. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your tax return is filed. The information provided is based on internal and external sources that are considered reliable; however, the accuracy of the information is not guaranteed.
Traditional IRA distributions are taxed as ordinary income. Qualified Roth IRA distributions are federally tax-free provided it has been more than five years since the Roth IRA was funded AND the owner is at least age 59 ½ or disabled, or using the first-time homebuyer exception, or taken by their beneficiaries due to their death. Qualified Roth IRA distributions are not subject to state and local taxation in most states. Distributions from Traditional and Roth IRAs may be subject to an IRS 10% additional tax if distributions are taken prior to age 59 ½.
Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC, Member SIPC, a registered broker-dealer and non-bank affiliate of Wells Fargo & Company.
paid advertisement
PM-04022026-6032763.1.2