529 Plan

This post is for knowledge sharing only. It is not intended to be investment or tax advice.


529 Plans are tax-advantaged accounts specific for education saving:

  • Contribution are made with after-tax dollars.
  • Growth within the account is tax-free.
  • Withdraw for qualified education expenses is also tax free.

Roth IRA First

529 Plans are very similar to Roth IRA. But Roth IRA withdraw under the 5-year rule is tax free for any purpose.

Therefore, unless for the state tax deduction in some states, it is always better to max out Roth IRA first (through backdoor and mega backdoor for high income earners) before funding a 529 plan.

Note: there is NO California state tax deduction for any 529 plan.

529 or Not?

Here are some considerations in reality before funding a 529 plan:

What if no qualified education expenses

In the worst case that there will be no qualified education expenses, you can still take money out for non-qualified expenses, but you have to pay:
  • federal income tax + 10% federal penalty on earnings
  • state income tax, plus 2.5% state penalty if in California, on earnings
  • recapture of the state tax deduction in some states.
Here are some good news to alleviate the concern:
  • IRS also allows to use 529 to pay up to \$10,000 annually per beneficiary for K-12 tuition.
    • Be aware that California treats K-12 tuition as non-qualified expenses.
  • One can change a 529 plan's beneficiary to qualified family members of the current beneficiary, in case the current beneficiary won't go to college for example.
  • The penalty of non-qualified expenses can be waivered, for example, when the beneficiary has dead, becomes disabled or receives scholarships, etc. See IRS exceptions for details.
  • Starting from 2024, some amount in 529 accounts can be rollovered to the beneficiary's Roth IRA. See this article for more details on the limit and conditions.

Investment restrictions

IRS imposes investment restrictions in 529 accounts:
  • The investment options are limited:
    • There are only a pre-set list of portfolios for selection. 
    • One can NOT invest individual stocks or ETFs as in ordinary brokerage account.
  • There is also investment change limit: normally no more than twice per year. 
  • 529 accounts only take cash contribution, i.e. one can NOT directly transfer securities into 529 accounts. 
BTW: Unlike 529, a Coverdell education saving account can be self-directed. But it is only available for low income families.

The good news is that such restrictions do NOT bring troubles if the investment strategy is to buy and hold low-cost index funds following Warren Buffett's advice.

The only drawback is then the investment cost of index funds in most 529 accounts is higher than the cost of the same funds in ordinary accounts because of the additional program management fee. For example, 

529 for wealth transfer

In 2024, the federal lifetime gift and estate tax exemption is \$13.61 million per person and \$27.22 million per married couple. The exemption amount is so large that ordinary people do not need even to worry about such tax. However, note that the current exemption amount is doubled in the Tax Cut and Job Act of 2017, which is supposed to expire in 2025. So the exemption amount is expected to be cut by half starting from 2026. The point is that it is possible that exemption amount will continue to be cut down in future by democrats, and eventually drops to the wealth range of middle class families.

A 529 plan can be used for generational wealth transfer because of the following features:
  • Unlike IRA, the money in 529 plans is exempted from federal estate tax.
  • Unlike IRA, there are no required minimum distributions. So the money can grow in a 529 plan forever.
  • Both the beneficiary and the owner of a 529 plan can be changed.
See the last section of Dynasty 529 for more details.

Which state's 529?

529 plans are established and maintained by states (for example, the Vanguard 529 plan is sponsored by Nevada state). Each state provides its own 529 plan and rules, which makes 529 rules complicate on the state level.

Note that one is free to choose most state's 529 plans, NOT necessarily the resident state's plan. Here is the tool from Save for College to compare all 529 plans offered by each state.

Once contributing to a out-of-state 529 plan, make sure to understand (important)
  • the rules of the out-of-state 529 plan.
  • the state tax law of the residence state as well as other states in which one pays tax.
Here are some considerations in order when to select a 529 plan:

1. Eligibility

Currently, there are 7 states that offer 529 plans ONLY to their residents. These plans are usually pretty good as a in-state benefit.

For example, Florida 529 plan offers the cheapest index funds to Florida residents: the total expense ratio of its U.S. Large Cap Equity Index Fund and U.S. Broad All Cap Index Fund is only 0.02%, which is even lower than the 0.04% cost of the corresponding Vanguard 500 Index Fund Admiral Shares (VIFAX) and Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX) in ordinary accounts.

2. State Tax Deduction

See this list for each state's rule on 529 state tax deduction or credit. For example,
  • One can receive New York state tax deduction for the contribution to New York's 529 if paying New York state income tax (NOT necessarily as a New York resident).
  • For Maine state taxpayers, the contributions to ANY 529 plan can get Maine state tax deduction.
  • There is NO California state tax deduction for the contributions to any 529 plan. So California residents without any out-of-state income does not need to consider the feature of tax deduction when selecting 529 plans.
Consider to choose the state's plan when there are state tax benefits available (unless the plan charges a high fee or the investment options are not good). Once enjoyed state tax deduction, pay attention to the state tax recapture provisions.

3. Investments and fees

Personally, I only consider the investment options of low-cost index funds. Recall that the total expense ratio of NH Fidelity 500 Index Portfolio is 0.11%, so any 529 plan with the total cost above 0.11% is out of my consideration.

Here are some cheapest index funds I find in 529 plans with no restrictions on state residency:

Portfolio 529 State Total Fee Underlying Fund Benchmark
Vanguard 500 Index 529 Portfolio IL 0.09% VIIIX S&P 500
Index U.S. Equity Portfolio CA 0.06% TIEIX Russell 3000
Total Stock Market Index Portfolio VA 0.068% VSMPX CRSP US Total Market Index
Large Cap Growth Equity Index Option MI 0.085% VIGIX CRSP US Large Cap Growth Index

See this list for a quick look at the program management fees and investment expenses of all 529 plans. 

4. Flexibility of changing ownership and beneficiary

This should be considered if the goal is to establish a dynasty 529 plan as described in the next section.

Dynasty 529

Since a 529 plan can be used as a tool for generational wealth transfer, some people may want to contribute than their children's college expense for either estate planning or multigenerational education planning. 

Unlike IRA, there is no annual contribution limit to a 529 plan. But in practice, there are several limits to be considered:
  • Annual gift tax exclusion limit
    • Although the money in a 529 plan is exempted from federal estate tax, the contribution to a 529 plan is treated as a gift from the owner to the beneficiary, and thus subject to the gift tax and generation-skipping transfer (GST) tax.
    • If the contribution amount is more than annual gift tax exclusion limit (\$18,000 in 2024), the the excess amount is added towards the lifetime estate and gift exemption limit.
    • Once the lifetime estate and gift exemption limit is reached, the contributions get taxed by the gift tax as well as GST tax if the beneficiary is more than one generation below.
  • Aggregate contribution limit per state
    • Each state sets an aggregate contribution limit for all the 529 accounts of the beneficiary within the state.
    • Once the aggregate limit is reached, no more contributions can be made. But the money in the plan can still grow with no limit.
Some solutions to maximize contributions:
  • Superfund a 529 plan using the five-year gift-tax averaging.
    • to contribute more amount beyond the annual gift tax exclusion limit without counting towards the lifetime estate and gift exemption limit.
    • to contribute more principals before the account balance reaches the aggregate limit.
  • Open 529 accounts in multiple states for the same beneficiary since each state counts its own aggregate contribution limit.
  • Change the beneficiary or rollover a 529 plan to another 529 plan of a new beneficiary.
    • The money in the plan is treated as a gift from the current beneficiary to the new beneficiary if the new beneficiary is below the generation level of the current beneficiary. The current beneficiary, not the account owner, may deal with the gift tax and GST tax.
  • Name the youngest possible beneficiary when opening a 519 account. 
    • There is NO gift or GTS tax when the the new beneficiary is at the same or above generation level of the current beneficiary.
  • Select 529 plans with less or no restrictions on rollover and changing ownership.
Location: 美国加利福尼亚帕罗奥图

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