Education Savings Plans

529 Plans Overview

Section 529 plans, named after Section 529 of the Internal Revenue Code, are tax-advantaged savings plans designed to encourage saving for future education costs. These plans are sponsored by states, state agencies, or educational institutions and are one of the most popular vehicles for education savings in the United States. Series 6 representatives frequently recommend 529 plans, making this a critical exam topic.

There are two types of 529 plans:

529 Savings Plans (College Savings Plans): These are the most common type and function similarly to mutual fund accounts. The account owner contributes money that is invested in a selection of investment options (typically mutual fund-like portfolios). The value of the account fluctuates based on market performance. This is the type most relevant to Series 6 representatives.
529 Prepaid Tuition Plans: These allow the account owner to purchase tuition credits at participating colleges and universities at today's prices. They guarantee that tuition will be covered regardless of future price increases. These plans are less common, are typically limited to in-state public schools, and are generally not sold by securities representatives.

529 Plan: A tax-advantaged savings plan authorized by Section 529 of the Internal Revenue Code, sponsored by states or educational institutions, designed to help families save for qualified education expenses. Contributions grow tax-deferred, and withdrawals used for qualified expenses are tax-free at the federal level.

Key Features of 529 Savings Plans

Tax-deferred growth: Earnings within the account grow tax-deferred at the federal level (and often at the state level as well).
Tax-free withdrawals: Withdrawals used for qualified education expenses are completely free from federal income tax.
State tax deductions or credits: Many states offer a state income tax deduction or credit for contributions to their state's 529 plan. Some states offer this benefit for contributions to any state's 529 plan.
High contribution limits: While there is no federal limit on annual contributions, each state sets its own maximum aggregate balance (typically $300,000-$500,000 or more per beneficiary). Contributions above the annual gift tax exclusion amount may trigger gift tax implications.
Account owner control: The account owner (not the beneficiary) maintains control of the account. The owner decides when withdrawals are made and can change the beneficiary to another qualifying family member at any time.
No age limit: Unlike Coverdell ESAs, there is no age limit for the beneficiary. Adults can use 529 plans for their own education.
No income limit: Anyone can contribute to a 529 plan regardless of income level. This is a significant advantage over Coverdell ESAs, which have income restrictions.

Qualified Education Expenses

Understanding what constitutes a qualified education expense is essential for advising clients and for the Series 6 exam. Withdrawals used for qualified expenses are tax-free; withdrawals for non-qualified expenses are subject to income tax on the earnings portion plus a 10% penalty.

Qualified Higher Education Expenses

The following expenses at eligible educational institutions qualify for tax-free 529 withdrawals:

Tuition and fees: Required for enrollment or attendance at an eligible post-secondary institution.
Books and supplies: Required for courses of study.
Room and board: For students enrolled at least half-time. There are limits on room and board amounts for off-campus housing (the amount cannot exceed the school's cost of attendance allowance).
Computer equipment and technology: Computers, software, internet access, and related equipment used primarily by the beneficiary during enrollment.
Special needs expenses: Expenses for special needs services for a special needs beneficiary that are incurred in connection with enrollment or attendance.

K-12 Tuition (TCJA Expansion)

The Tax Cuts and Jobs Act of 2017 expanded 529 plan usage to include up to $10,000 per year per beneficiary for tuition at elementary and secondary schools (K-12), including public, private, and religious schools. This is limited to tuition only, not books, supplies, or room and board. Not all states conform to this federal expansion, so state tax treatment may vary.

Student Loan Repayment

The SECURE Act of 2019 further expanded 529 plan usage to include student loan repayment of up to $10,000 lifetime per beneficiary. This means 529 funds can be used tax-free to pay down student loans, providing flexibility for families who have leftover 529 funds after the beneficiary completes their education.

If 529 funds are withdrawn for non-qualified expenses, the earnings portion of the withdrawal is subject to federal income tax at the account owner's ordinary income tax rate PLUS a 10% federal penalty. The contribution portion (the original amount invested) is always returned tax-free because contributions are made with after-tax dollars. Some states may impose additional penalties.

Gift Tax Treatment and Superfunding

Contributions to a 529 plan are considered completed gifts for federal gift tax purposes. This means the contributed assets are removed from the account owner's estate, which provides estate planning benefits. The gift tax treatment of 529 plans has unique features that are frequently tested on the Series 6 exam.

Annual Gift Tax Exclusion

Contributions to a 529 plan qualify for the annual federal gift tax exclusion. As of 2024, the annual exclusion amount is $18,000 per donor per beneficiary ($36,000 for married couples electing gift splitting). Contributions up to this amount do not require the donor to file a gift tax return or use any of their lifetime gift and estate tax exemption.

Superfunding (5-Year Election)

One of the most unique features of 529 plans is the superfunding provision, also known as the 5-year gift tax averaging election. This allows an account owner to contribute up to five years' worth of the annual gift tax exclusion in a single year and elect to treat the contribution as if it were spread evenly over five years for gift tax purposes.

For 2024, this means a single contributor could invest up to $90,000 (5 x $18,000) in one year, or a married couple could contribute up to $180,000 (5 x $36,000) without triggering gift tax. The donor must file IRS Form 709 (gift tax return) and elect the 5-year averaging for each of the five years.

Grandparents want to contribute to their grandchild's 529 plan. Grandmother contributes $90,000 in 2024 and elects 5-year gift tax averaging. For gift tax purposes, the $90,000 is treated as $18,000 per year for 2024-2028. She cannot make additional gifts to this grandchild during those five years without exceeding the annual exclusion.

If grandmother were to die during the 5-year period (say, in year 3), the remaining two-fifths of the contribution ($36,000) would be included back in her estate for estate tax purposes. The first three-fifths ($54,000) would remain excluded from her estate.

Estate Planning Benefits

529 plans offer powerful estate planning advantages. Because contributions are considered completed gifts, they are removed from the donor's taxable estate. Yet the account owner retains control of the account, including the ability to change the beneficiary or even withdraw the funds (subject to penalties). This combination of estate removal with retained control is unusual in the tax code and makes 529 plans attractive for wealth transfer planning.

State Tax Benefits

One of the most attractive features of 529 plans for many investors is the state income tax benefit. The details vary significantly by state, making it important for Series 6 representatives to understand their state's specific rules.

Types of State Benefits

Full state tax deduction: Many states offer a full or partial deduction from state taxable income for contributions to their state's 529 plan. Some states cap the deduction amount per year.
Tax credit: A few states offer a tax credit (a dollar-for-dollar reduction in tax owed) rather than a deduction, which is generally more valuable.
Parity states: Some states offer the same tax benefit for contributions to any state's 529 plan, not just their own. This gives investors more freedom to choose the best plan regardless of which state sponsors it.
No income tax states: States without an income tax (e.g., Florida, Texas, Nevada) do not offer a state tax benefit, but investors in those states should focus on plan quality, investment options, and fees when choosing a plan.

You do NOT need to know specific state tax benefits for the Series 6 exam. However, you should know that state tax benefits exist, that they vary by state, and that investors should consider their state's benefits when choosing a 529 plan. A representative should always inform clients about available state tax benefits as part of the recommendation process.

Coverdell Education Savings Accounts (ESAs)

The Coverdell Education Savings Account (formerly known as the Education IRA) is another tax-advantaged education savings vehicle. While Coverdell ESAs offer broader investment flexibility and wider qualified expense coverage than 529 plans, they have significant limitations that make them less popular for most families.

Key Features of Coverdell ESAs

Annual contribution limit: Only $2,000 per beneficiary per year from all contributors combined. This is dramatically lower than 529 plan limits.
Income limits: Contributors must have modified adjusted gross income (MAGI) below $110,000 (single) or $220,000 (married filing jointly) to make the full contribution. Contributions phase out between these amounts and $0 above the ceiling. This restricts high-income earners from contributing.
Age restrictions: Contributions must be made before the beneficiary turns 18 (unless the beneficiary has special needs). Funds must be used by age 30 or distributed (with taxes and penalties on earnings) or rolled over to another family member's Coverdell ESA.
Tax treatment: Like 529 plans, contributions are made with after-tax dollars, earnings grow tax-deferred, and qualified withdrawals are tax-free.
Broader qualified expenses: Coverdell ESAs cover K-12 expenses more comprehensively than 529 plans, including tuition, fees, books, supplies, equipment, tutoring, room and board, uniforms, transportation, and supplemental services. This was a major advantage before 529 plans were expanded to cover K-12 tuition.
Self-directed investments: Coverdell ESA funds can be invested in virtually any security (stocks, bonds, mutual funds, ETFs), giving the account owner more flexibility than 529 plans, which limit investment options to those offered by the plan.

Coverdell ESA vs. 529 Plan Comparison

Feature	529 Plan	Coverdell ESA
Annual Contribution Limit	No federal limit; state limits $300K-$500K+ aggregate	$2,000 per beneficiary per year
Income Restrictions	None	$110K single / $220K married (phase-out)
Age Limits	None	Contributions before age 18; use by age 30
K-12 Expenses	Tuition only, $10,000/year max	Tuition, books, supplies, room & board, more
Investment Options	Limited to plan's offerings	Self-directed; virtually any security
State Tax Benefit	Yes, in many states	No
Superfunding	Yes (5-year gift tax election)	No
Student Loan Repayment	Yes, up to $10,000 lifetime	No

For most families, 529 plans are superior to Coverdell ESAs due to much higher contribution limits, no income restrictions, no age limits, state tax benefits, and superfunding capability. Coverdell ESAs may still be useful as a supplement for families who want broader K-12 expense coverage or self-directed investment options, but the $2,000 annual limit severely restricts their usefulness as a primary education savings vehicle.

Rollovers and Beneficiary Changes

Changing the Beneficiary

The account owner of a 529 plan can change the beneficiary to another qualifying family member of the original beneficiary without tax consequences. Qualifying family members include siblings, parents, children, first cousins, spouses, in-laws, aunts, uncles, nieces, nephews, and step-relatives. This flexibility is valuable when one child does not need the funds (e.g., receives a scholarship) and another family member can use them.

Rollovers Between Plans

529 plan funds can be rolled over from one state's plan to another state's plan once every 12 months for the same beneficiary without tax consequences. There is no waiting period for rollovers that also change the beneficiary (as long as the new beneficiary is a qualifying family member). This allows account owners to move to a plan with better investment options or lower fees.

529-to-Roth IRA Rollovers (SECURE 2.0)

The SECURE 2.0 Act of 2022 introduced a significant new feature: beginning in 2024, unused 529 plan funds can be rolled over to a Roth IRA for the beneficiary, subject to several conditions:

The 529 account must have been open for at least 15 years.
Annual rollovers are limited to the Roth IRA annual contribution limit (currently $7,000 for those under 50).
There is a $35,000 lifetime maximum per beneficiary for 529-to-Roth rollovers.
Contributions made within the last 5 years (and their earnings) are not eligible for rollover.
The beneficiary must have earned income at least equal to the rollover amount.

Deep Dive Financial Aid Impact of Education Savings Plans

The impact of education savings plans on financial aid eligibility is an important consideration that clients often ask about. Here is how the major plans affect the FAFSA (Free Application for Federal Student Aid):

529 Plans owned by a parent: Reported as a parent asset on the FAFSA. Parent assets are assessed at a maximum rate of approximately 5.64% (meaning $10,000 in a parent-owned 529 might reduce aid eligibility by up to $564 per year). Qualified withdrawals from a parent-owned 529 are NOT counted as student income.

529 Plans owned by a grandparent: Under the simplified FAFSA rules effective for the 2024-2025 academic year and beyond, grandparent-owned 529 plans no longer need to be reported, and distributions are no longer counted as untaxed student income. This is a significant improvement that eliminates the previous disadvantage of grandparent-owned plans.

Coverdell ESAs: If the account is owned by the student or parent, it is reported as a parent asset on the FAFSA (similar to a parent-owned 529). If owned by a grandparent or other non-parent, the treatment follows similar rules to grandparent-owned 529s.

Custodial accounts (UGMA/UTMA): These are reported as student assets and are assessed at a rate of 20%, making them much less favorable for financial aid purposes. A strategy some families use is rolling UGMA/UTMA assets into a 529 plan to reduce the financial aid impact (though the beneficiary cannot be changed when 529 is funded with custodial assets).