There are a variety of ways to save for future college expenses, but 529 plans are often the preferred vehicle for doing so. 529 plans are tax-advantaged investment accounts that are funded with after-tax dollars, but offer tax-deferred growth and tax-free withdrawals for qualified education expenses. (From a tax standpoint, they are very similar to a Roth IRA.) In addition, they often allow for state tax deductions or credits as well.
Limitations of 529s
The main limitation of 529 plans is that withdrawals for any non-education expenses incur a 10% penalty and are subject to income tax on the gains. This effectively prevents using 529 plans for anything other than qualified education expenses, and means that you do not want to save more than you need in a 529 plan. However, note that:
- Qualified education expenses include a wide variety of costs including tuition & fees (including K-12 tuition up to $10k/yr), room & board, books & supplies, and even student loan repayment (up to $10k/beneficiary)
- You can change the beneficiary of a 529 plan at any time, to another child, grandchild or even yourself (in case, for example, the original beneficiary gets a scholarship or chooses not to attend college).
- With some limitations, you can transfer up to $35k of unused funds to the beneficiary’s Roth IRA.
Setting up a 529
Even though you can change the beneficiary on a 529 at any time, it is generally preferable to open a separate 529 account for each beneficiary. This is primarily because:
- A 529 plan can only have one beneficiary at a time, so if you have two children who will be in college at the same time, you cannot make qualified withdrawals for both of them.
- Children of different ages have different investment time horizons, and most 529 plans offer age-based portfolios that automatically adjust risk according to a single beneficiary’s timeline.
- State tax deductions or credits for contributions are often applied per beneficiary, so having separate accounts allows you to maximize these state-specific tax benefits.
- The Roth IRA rollover option requires the 529 account to have been open for at least 15 years for that specific beneficiary.
529 plans are administered by the states, and each state offers their own flavor of 529. You are not limited to your state’s 529 plan, and should generally only bias towards your own state’s 529 if (1) the state tax benefits are worth it, and (2) the state offers a high quality plan (good investment options, reasonable fees, etc). Since most of Palisade’s clients live in a few states, here are some recommendations for those states:
If you live in: | We recommend you consider a 529 plan from: |
|---|---|
Utah | Utah, since it has one of the highest rated 529 plans, and offers a state tax credit as well. |
California | Utah (or another highly rated 529 plan), since California offers no 529 tax benefits. |
Colorado | Colorado: while its 529 plan is reasonably good, its state tax benefits are among the strongest (high deduction limit, 100% deductible contributions, per-beneficiary deductions). |
Contributions to a 529 plan are generally limited by the gift tax exclusion ($19k in 2025, or $36k per couple), but there is an option to “superfund” a 529, allowing you to front-load the 529 with five years worth’ of contributions in year one. There are some tradeoffs with superfunding, however, so some additional due diligence is recommended.
