Plan for educational expenses with 529 plans
Key takeaways:
- The invested money grows tax-deferred and is tax-free on withdrawal if used for covered educational expenses.
- Most states allow the individual making the contribution to claim a state income tax credit.
An important part of financial planning for physicians with children can be 529 plans.
529 plans are state-sponsored plans that receive after-tax dollars that can later be spent on college or post-graduate educational expenses. 529 funds can also be used for up to $10,000 per year in K-12 tuition expenses. The biggest benefit of 529 plans is that invested money grows tax-deferred, and then on withdrawal is tax-free if it is utilized for covered educational expenses.
Investment options
How much money can I put into a 529 each year per child? In 2025, the annual gift tax exclusion is $19,000 for an individual giving to another individual, meaning no tax would be owed on this money. Each parent can gift up to that amount per child. For example, a married couple with two children could contribute up to $38,000 for each child for 529 plans separately assigned in each child’s name.
What about grandparents, godparents, other relatives and friends? Other individuals can also contribute up to $19,000 a year per child per plan. There is no limit to the number of individuals who may contribute to a plan.
Is there a tax benefit to 529 contributions? Most states allow the individual making the contribution to claim a state income tax credit. The only states that are excluded are states without income tax and three income-tax states (California, Kentucky and North Carolina).
The amount of the income tax credit varies state to state, and some states require investing in their own state’s plan to receive the credit, while nine states are plan-agnostic (Arizona, Arkansas, Kansas, Maine, Minnesota, Missouri, Montana, Ohio and Pennsylvania).
Can I contribute more than $19,000 this year without exceeding the gift tax exclusion? Yes, you actually can “pre-contribute” up to 5 years of gift all at once. For example, one could put in up to $95,000 as a contribution in 2025 and simply have the gift apply for the tax years 2025 to 2029. However, you would not be able to contribute without gift tax penalty again until 2030.
What investment options are there within a 529 plan? It depends on the state whose plan you choose. Assuming there is an income tax credit tied to your state, it is probably worth sticking to your own home state. If there is no income tax credit or your state is agnostic, then you can choose any state’s plan. Certain states offer more investment vehicles than others.
In terms of the type of asset to invest in, it depends on your timeframe and risk tolerance. If you are investing for expenses more than 10 years in the future, consider starting with low-cost broad-based index stock funds and then rebalance with less volatile investments as you approach your target date. If you are investing for relatively short time horizon (eg, less than 5 years), consider a more conservative asset allocation with bonds and money markets. Some states, like Massachusetts, offer funds that automatically rebalance for you, becoming more conservative as you approach your target date.
Rollover options
What happens when my child turns 18 years? Do they take over the 529 account? The original account holder (ie, the parent) still maintains control.
What happens if my child does not use all of her 529 funds for her education? If a child gets a scholarship or does not go to college, for example, the parents can roll over funds to a different child’s plan or even another family member’s plan (eg, niece, nephew or grandchild). As of 2024, the SECURE Act 2.0 allows up to $35,000 of a 529 account to be rolled over into a Roth IRA account for the beneficiary. This is an excellent way of helping your child jumpstart their retirement savings ($35,000 invested at a 6% return for 45 years yields $480,000 in tax-free retirement income). Finally, the account holder also can withdraw and use the funds on nonqualified expenses. However, in addition to paying taxes, a 10% penalty would apply to earnings.
How much should I invest in a 529? Interestingly, at the time of this writing, college tuition costs tend to increase about 4% to 5% a year. This rate is similar to the rate of return of a balanced 529 plan portfolio. Thus, consider investing in a 529 account until the balance is about the current cost of college.
For more information:
Chirag P. Shah, MD, MPH, is a soccer and Nordic ski coach, who also practices medicine and teaches in Boston. He can be reached at cshah@post.harvard.edu.
Jayanth Sridhar, MD, is an award-winning podcaster, physician and educator who is chief of ophthalmology at Olive View Medical Center in Los Angeles. He can be reached at jsridhar119@gmail.com.
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