5 Overlooked Tax Benefits of 529 Plans

Contributing to a 529 plan is one of the smartest ways to save for your child’s future education—and it comes with many benefits that extend beyond just paying for college tuition.

While many people are aware of the ability to save for college in these plans, fewer understand the significant tax advantages that come with contributing to a 529.

1. Tax-Free Withdrawals for Qualified Education Expenses

The most well-known tax benefit of a 529 plan is that you can withdraw funds tax-free when you use them for qualified education expenses. While we often think about 529 plans in terms of college costs, the plan can be used for a broad range of educational expenses.

Qualified expenses typically include:

• Tuition

• Room and board

• Books and supplies

• Computers and related technology

• Special needs equipment

• Apprenticeship program costs

However, there are some non-qualified expenses, such as:

• Transportation costs (e.g., flights or train tickets)

• College test prep or entrance exam fees

• Health insurance purchased through the school

• Extracurricular activity fees

2. Repaying Student Loan Interest and Principal

Did you know you can use a 529 plan to help pay off student loans? As part of the SECURE Act, it’s now possible to use 529 funds to pay up to $10,000 per year in student loan principal and interest for the beneficiary or even for each sibling of the beneficiary.

This is a lifetime limit of $10,000 per person, which is a great benefit if your child has multiple 529 accounts, or if you, as a grandparent, have contributed to the 529 plan as well. The ability to use the 529 to pay student loans is an often overlooked advantage of this savings tool.

3. Paying for K-12 Education

It’s not just college expenses that you can use a 529 plan for. K-12 education expenses are eligible, too! You can withdraw up to $10,000 per year for tuition at private K-12 schools. This gives families with younger children a valuable option to pay for private education with tax-free withdrawals.

Keep in mind, though, that room and board or books aren’t covered for K-12 schools, and you’ll want to check with your state for any differences in what qualifies for tax-free distributions.

4. Tax-Deferred Growth

One of the biggest advantages of contributing to a 529 plan is tax-deferred growth. Once you invest in a 529 plan, the money grows without being taxed each year. This is a major benefit over other savings vehicles, where you might have to pay taxes on interest, dividends, or capital gains annually.

With a 529 plan, you don’t pay tax on those gains year after year, so the money you’ve invested is allowed to grow and compound more effectively. Plus, when you take the funds out for qualified education expenses, those gains are tax-free as well.

For example, if you contribute $10,000 to a 529 plan, and it grows to $20,000 over time, you won’t pay any tax on that $10,000 in gains as long as you use the funds for qualified expenses. This makes a 529 plan an effective tool for long-term saving.

Shipped to your door!

Available on Amazon Marketplace (click the image)

5. Roth IRA Conversion Option (529 to Roth)

A newer development, made possible by the SECURE Act 2.0, is the ability to move money from a 529 plan into a Roth IRA for the beneficiary. This option allows up to $35,000 per beneficiary to be moved into a Roth IRA.

This is a huge win because Roth IRAs offer tax-free growth, and the funds you move over from a 529 plan can continue growing for the beneficiary’s retirement, even if they don’t need it for education costs. There are a few requirements to meet:

• The 529 plan must be open for at least 15 years.

• The beneficiary must have earned income (such as a part-time job) equal to or greater than the Roth IRA contribution you wish to make.

This option opens up a great opportunity for building wealth, especially for children who receive scholarships or decide not to attend college, giving them a head start on retirement savings.

Bonus Tip: State Tax Deductions

Last but certainly not least, many states offer a state tax deduction for contributions to a 529 plan. There are 30 states that provide a state income tax deduction or credit for contributions to a 529 plan, which can provide immediate savings.

For example, in my home state of Connecticut, you can contribute up to $5,000 per individual ($10,000 for married couples) to a 529 plan and receive a tax deduction on your state income taxes. Depending on your state’s tax rate, this can result in substantial savings.

Other states, like New York, Rhode Island, and New Jersey, offer similar tax benefits, but the amount and eligibility vary. It’s crucial to check with your state to see if they offer a tax deduction and whether contributions to out-of-state plans are eligible.

If you prefer to learn in video format. Make sure to check out my YouTube channel! Don’t forget to subscribe!

Closing Thoughts

As you can see, a 529 plan is not just for saving for college—it’s a versatile tool that offers significant tax benefits. From tax-free withdrawals for qualified education expenses to the ability to move money into a Roth IRA and even benefit from state tax deductions, a 529 plan can be a smart financial strategy for parents, grandparents, and even retirees.

If you’re interested in maximizing your tax benefits before the year ends, be sure to make your contributions before December 31st. And don’t forget to consult your accountant to ensure you’re taking full advantage of these benefits.

I hope this breakdown of the top 5 tax benefits of a 529 plan helps you plan for the future more effectively. Stay tuned for more tips on retirement planning, taxes, and wealth-building strategies in upcoming posts!

Remember, every step you take today can bring you closer to securing a brighter future for you and your loved ones.

If you have a question or topic that you’d like to have considered for a future episode/blog post, you can request it by going to www.retirewithryan.com and clicking on ask a question. 

As always, have a great day, a better week, and I look forward to talking with you on the next blog post, podcast, YouTube video, or wherever we have the pleasure of connecting!

Written by Ryan Morrissey

Founder & CEO of Morrissey Wealth Management

Host of the Retire with Ryan Podcast