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The 529 Plan: How to Make the Most of It

Everything seems to be getting more expensive these days: groceries, gas, housing, traveling, credit card interest rates, healthcare, and higher education, just to name a few. Unfortunately, inflation doesn’t explain everything, especially regarding college education costs, which have consistently outpaced inflation since 1977. 

Tuition vs. Inflation Chart

Source: https://www.minneapolisfed.org/about-us/monetary-policy/inflation-calculator/consumer-price-index-1913-

This phenomenon of consistently rising tuition costs is, perhaps unsurprisingly, known as ‘tuition inflation.’ Its reasons and causes are beyond the scope of this article – instead, we will focus on how we can plan for these rising costs as part of your broader financial plan with the help of a surprising ally – the IRS. 

How much does college these days cost? 

Of course, it’s difficult to nail down anything super specific when trying to determine what college costs will be like for your family’s specific situation. Tuitions vary greatly across degree programs, colleges, and states, and whether or not the student qualifies for in-state tuition. However, we can paint a broad brush to help us come to certain conclusions, mainly that college is terrifically expensive. 

In 2024, the annual cost of a four-year degree in a public, local university is a bit over $100,000, including tuition, housing, books, and living costs. We usually help offset those costs by working. Still, college children may not have that opportunity, especially if they prefer to focus on their studies instead of trying to juggle a job and classes.

Institution Type Annual Cost Cost Over 4 Years
Public 4-year in-state $26,027 $104,108
Public 4-year out-of-state $27,091 $108,364
Private, Nonprofit University $55,840 $223,360

Source: https://educationdata.org/average-cost-of-college

How much WILL college cost?

What can we expect college prices to be like in 18 years? From 1977 until the current year, college tuition‘s average inflation rate has been 6.08% per year – beating out regular inflation. If historical trends continue, that same $27,091 annual public out-of-state tuition will rise to $78,526 by 2044. 

How to Afford Rising Tuition Costs 

As a parent, you have a few choices if you plan on helping your child pay for college, including but not limited to: 

  1. Cosign high-interest-rate loans (and put your own finances at risk)
  2. Start saving early (and constantly play catch up with inflation and tuition inflation) 
  3. We’ll get to this one in a minute. 

Let’s imagine you’ve just had a child and expect them to go to an out-of-state college in 18 years. Looking at historical trends, we can see that you’ll need around $78,000 a year for about four years – so about $312,000. 

If you were to just put enough money away each year into a savings account, you would need to save over 17,000 per year to reach your goals. 

Saving such a significant amount monthly for 17 years until your child begins college can be a daunting financial commitment! And what if you have multiple children? 

Moreover, merely saving money in a standard account doesn’t shield us from the impacts of inflation and tuition inflation. The dollar you have today is likely the strongest it will ever be. So, what can we use instead of cash to grow our wealth? 

Fortunately, the IRS is here to save the day – in a way. 

The 529 College Savings Plan

The 529 Savings Plan is an investment account with a twist—any profits earned within the account grow tax-free, and withdrawals for qualifying college and K-12 expenses are tax-free as well. 

However, the 529 Plan doesn’t allow you to deduct your contributions from your taxable income, like an IRA or 401(K) would allow for. 

The point is that you can purchase investments such as stocks and bonds—investments that have the potential to outpace inflation and tuition inflation over the long term. 

Let’s return to our original example of saving for a $312,000 college education. If you simply saved up cash, you’d need to save about $17,300 a year. What if you were to invest $17,000 a year instead? How quickly would you reach your goal (and how much money would you save for yourself) by investing?

Let’s imagine you could achieve a 10% annual rate of return. By investing $17,300 a year with a 10% rate of return, you could reach your $312,000 goal in only 11 years. And by contributing fewer funds overall, you’d save $121,337.

But that’s just one way. You could simply invest less into your child’s college fund each year and use the excess as necessary to achieve your other financial goals.

Contributing To and Superfunding Your 529 Plan

529 contributions do count as gifts, meaning they risk taxation if they go over certain limits. You can contribute up to the annual gift tax exclusion per beneficiary per year, and if you’re married, you can combine your ‘gifts.’ You’ll owe a gift tax if you go over $18,000 in 2024. Maybe.

Account 2024 Contribution Limits Catch-up Provision for Those Over Age 50 Income Limits or Other Considerations
529 College Savings Plan Varies by state N/A Giving $18,000 or less to an individual qualifies for annual gift tax exclusion. Married couples can give a combined $36,000.
401(k) $23,000 $7,500 Annual compensation limit: $345,000. Total employee and employer contributions: $69,000.
Traditional IRA $7,000 $1,000 No income limit as long as the taxpayer or spouse aren’t covered by a retirement plan at work; 6% penalty for over-contributing.
Roth IRA $7,000 $1,000 Annual income cannot exceed MAGI of $161,000 (single)/$240,000 (married, filing jointly). 6% penalty for over-contributing.
Health Savings Account (HSA) $4,150, individual; $8,300, family. $1,000 (individual or family coverage) Catch-up provision begins at 55.

The IRS also allows you to make a lump sum contribution equal to five years’ worth of contributions. Basically, you spread the contributions over a five year period on paper, with the caveat that you can’t make any more contributions over the next five years to that beneficiary. 

Essentially, you can contribute $90,000 to a 529 plan today without paying gift tax on it, reducing your taxable estate by a considerable amount – especially if you factor in the years of future growth it may experience. This is why 529 plans are often considered as valuable estate planning tools.  

Qualifying College Expenses

Type of Expense Is it a Qualified Education Expense?
Tuition and fees Yes, includes all college or vocational school tuition and required fees. For K-12, limited to $10,000 per year.
Room and board Only qualified for college, if the student is enrolled at least half-time.
Computers, software, and internet access Eligible for college expenses only.
Special needs equipment Applicable for college expenses only.
Books and supplies Qualified for college expenses only.

Why Not Use a Different Account?

The issue with saving for college in a brokerage account is that you’ll be taxed on your growth and withdrawals. As for a retirement account, such as an IRA or Roth, you may be subjected to early withdrawal penalties and taxes, depending on your age and the status of your funds. In any case, those funds are earmarked for retirement – it’s best to keep them that way! 

What Happens to Excess or Unused 529 Plan Funds?

Excess or unused funds in a 529 College Savings Plan can be handled in a few different ways, depending on the plan holder’s preferences and circumstances. Here are the main options:

Change the Beneficiary: One of the most common solutions for unused 529 plan funds is to change the beneficiary to another family member who can use the funds for educational expenses. The new beneficiary could be a sibling, a cousin, a grandchild, or even a parent—anyone who is a relative of the original beneficiary. This flexibility helps ensure the money stays within the family and continues to be used for educational purposes without incurring penalties.

Keep the Funds in the Plan: You may choose to keep the funds in the plan if the beneficiary might pursue further education in the future, such as graduate school. 529 plans do not have a time limit for when the money must be used, which provides flexibility in planning for a beneficiary’s educational path.

Roll the Funds Into a Roth Account: As of January 1, 2024, account holders can roll over 529 funds into a beneficiary’s Roth account provided the rollover amount has been in the account for at least five years and the account has been open for at least 15 years. There is a lifetime limit of $35,000, and annual contribution limits apply.  

Some Caveats

We should keep in mind that a 529 plan may help us reach our goals faster – and it may not. Investing is risky; you may even lose money, or the markets may crash when you need your funds. It’s important to rebalance to more conservative investments the closer you get to needing your funds and factor your investments into your broader financial plan.

In Conclusion

As education costs continue to rise, preparing financially for college expenses is more crucial than ever. The 529 College Savings Plan offers a robust solution by allowing earnings to grow tax-free with tax-free withdrawals for qualified educational expenses. It even comes with side benefits, such as maintaining control over the plan’s beneficiaries and the ability to execute Roth rollovers. 

However, as with all investment decisions, it’s wise to consult with a financial professional who can help you determine if a 529 plan is the best option for your financial circumstances and goals. Given the inherent riskiness of investing, perhaps there are alternative solutions or strategies. That’s why a consultation with a CPA Retirement Solutions advisor can be helpful – we can educate you on all of your possible options to help you choose the one that makes the most sense for you. Click the button below to schedule an appointment! 

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Author

  • Robert Belcuore

    Robert received a master's degree in administration and supervision at Jersey City State College, a degree in Educational Administration, and a (doctorate equivalent) from Montclair State University in Pedagogy. He completed his undergraduate studies in political science at the University of Connecticut.

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