Many families open a 529 plan for tax-advantaged education savings, but do these accounts make sense for high-earners? The answer is yes; these accounts can be a smart wealth strategy for high-income families. The rules allow anyone to set up a 529 account and name anyone as a beneficiary, including relatives, friends, or even themselves. They offer tax-free growth when used for qualified education costs and help wealthy families move assets out of taxable estates while the donor maintains control with account ownership. Also, a more recent Roth IRA rollover pathway allows some flexibility for unused funds.
Coordinating with tax and wealth management advisors is key to taking advantage of the tax and wealth planning benefits these plans offer.
529 Account Tax Benefits Overview
Here are the key tax benefits that make 529 accounts attractive for college savings and broader wealth planning:
- Tax-deferred (and potentially tax-free) growth: Earnings compound without current federal income tax, and withdrawals are federal income tax-free when used for qualified education expenses.
- State tax deductions/credits: Many states offer an income tax deduction or credit for 529 contributions; they often have rules about using the in-state plan.
- Gift- and estate-planning benefits: Contributions can qualify for the annual gift tax exclusion, and frontloading (aka superfunding) allows bigger contributions to be treated as spread over five years for gift tax purposes while moving assets out of the taxable estate.
- Roth IRA rollover pathway allowed for unused funds: Some unused 529 funds may be rolled into a Roth IRA for the beneficiary, offering another tax-advantaged use for money not used or needed for education.
The 529 Plan Superfunding Strategy
The IRS says you can’t contribute more to a 529 plan than what’s needed for the beneficiary’s qualified education expenses, but there’s no income limit for those who want to contribute. Remember, though, that if you give more than $19,000 to a person, including a contribution to their 529 plan, you would be required to file Form 709 in the first year of the five-year election to report one-fifth of the gift amount. However, you can avoid paying the gift taxes on the contributions by doing five-year tax averaging, or superfunding.
Superfunding is the strategy of front-loading a 529 plan by making a lump-sum contribution equal to five years’ worth of annual gift exclusions, then spreading that amount over five years for gift tax purposes. You then won’t need to file the form again, unless you give the person any more reportable gifts.
Many families use 529 plan superfunding to their advantage. This strategy is best for grandparents with estate reduction goals and parents trying to lock in more years of tax-free compounding early.
State Tax Strategy: In‑State vs. Out‑of‑State 529 Plans
When setting your tax strategy, consider that many states offer a deduction/credit only if you use the home-state plan. Other states have “tax parity,” meaning they allow deductions for contributions to any state’s plan. Illinois, for example, has a state income tax deduction for contributions up to $10,000 for single filers and $20,000 for married couples filing jointly, only if they are made to an Illinois-sponsored 529 plan.
For wealthy families, a state deduction can be beneficial, but sometimes you are hit with other costs. For example, some state plans come with fees that could outweigh the deduction. Also, the state plan might not fit in with your overall wealth strategy if it is limited or doesn’t perform well. You might also care about asset protection, and some 529 plans offer different protection levels depending on your state. Work with an advisor to help you figure out which is the most advantageous choice for your unique situation.
Ownership and Control of 529s
For many families, especially high-net-worth individuals, ownership and control of the account is essential. In general, most 529 plans allow owners to control the investments and distributions, although that can vary by plan rules. Owners can also change the beneficiary within the family, which can be helpful when you have multiple children and education plans change.
Families often choose different owners — such as parents, grandparents, or trusts — depending on who they want to control the account and how the 529 fits into their broader wealth and estate plan.
529 Plan vs. Roth IRA: Differences and Uses
While both 529 plans and Roth IRAs offer tax advantages, they offer different purposes and have their own rules. A 529 plan is primarily designed for education savings, offering tax-free growth and used for qualified education costs. A Roth IRA is a retirement account that allows after-tax contributions and tax-free withdrawals in retirement. For high-income families, Roth IRAs are often limited by income thresholds.
Unused 529 funds can be rolled to a Roth IRA for a beneficiary, connecting education and retirement planning. This helps families who are phased out of direct Roth IRA contributions. When deciding between the two, work with an advisor and consider your family's needs, the beneficiary's earned income, and long-term financial goals.
How 529s Offer Flexibility to Transfer to Roth IRAs
A key benefit of a 529 plan is that certain unused funds may be rolled into a Roth IRA for the same beneficiary, subject to certain rules, including:
- A lifetime maximum of $35,000 per beneficiary.
- Funds must have been in the 529 for 15 years.
- The annual rollover is limited by annual Roth IRA contribution limits.
- Funds contributed within the past five years can’t be moved.
- The beneficiary must have earned income.
For high-income families who are otherwise phased out of Roth IRA contributions, this offers a way to reuse the funds and creates an opportunity to jumpstart retirement savings for grandchildren and children. Despite the $35,000 rollover limit, this move still significantly helps the beneficiary by starting their Roth savings at a younger age.
Coordinating 529 Funding with Wealth Planning
When you're building a comprehensive wealth plan, consider how your 529 contributions fit in with your annual gifting strategy and other ways you might transfer assets, like cash, stocks, or even trusts. These pieces all work together to maximize your family's financial benefits and long-term goals.
For high-income families, 529 plans offer a lot of flexibility. But to truly make the most of these benefits, it pays to coordinate your 529 strategy with your overall gifting approach, stay aware of state tax rules, and consider the timing of financial aid.
Need help figuring out the best approach? Our wealth management team can help you understand state tax advantages, choose who should own the 529 account, strategize how to frontload your contributions, and plan for any funds you might not use.