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The pros, cons and how-tos of 529 plans

What do I need to know about 529 plans?

Whether your child is in middle school or a newborn, it’s a great time to think about how you’ll cover her education costs. For families with higher income and net worth, Section 529 plans are very popular vehicles to fund not just college tuition, but private kindergarten through high school expenses as well.

529 plans are popular mainly thanks to:

  • Tax advantages of contributions and distributions

  • The amounts you may deposit on a yearly basis

  • The control the contributor may have in the plan

529 plan, defined

A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. They’re sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.1

How much can we contribute to a 529 plan? (And what about gift taxes?)

If you’re a single filer, you can contribute up to the annual gift exclusion, currently $16,000 per year as of 2022, without incurring gift taxes. And if you’re a married couple filing jointly, the amount jumps to $32,000 per year. Beyond that amount, you’ll have to pay gift tax.

There is, however, a way for you to front-load 529 plans with up to five years' worth of gifts.  For an individual you may contribute $80,000 ($160,000 for married joint filers) in one year and treat that gift as if it were spread out over five years without incurring gift taxes.  Note, you will not be allowed to gift to that specific recipient or the 529 plan until five years have passed, unless you're willing to pay gift taxes, utilize lifetime estate and gift exemption or if the annual gift tax exclusion is increased.

Let’s look at the pros and cons of 529 plans.

529 Pros

Income tax benefits

  • When used for college or K-12 qualified expenses, earnings are not subject to federal income tax.
  • If not used for qualified expenses, federal income tax on the earnings is deferred until distribution.
  • Many states offer a state income tax deduction for contributions to those states’ 529 plans, making it attractive for their residents to choose their plan over those offered by other states. Some states even offer tax deductions on contributions to other plans.


  • Unlike any other gifts, you can retain control over your gift with no “bad” estate tax consequences. You can also change the beneficiary to certain family members with no tax consequences, or take the funds back (subject to a 10% additional tax on earnings).
  • Parents are not the only ones who can set up 529 plans for their children. Grandparents, siblings or even friends can contribute to a 529 plan even if they are not the account owner.
  • You can contribute to a 529 plan in any state, not just the one you live in. For example, if you live in Pennsylvania, and Utah’s plan will be more beneficial than Pennsylvania’s, you’re permitted to use a Utah 529 even though you don’t live there.

Gift tax

You can contribute using the annual exclusion for five years (front-loading). The advantage of front-loading is that earnings can begin to build tax-free faster than if you made separate contributions each year.

529 Cons

10% additional income tax

If not used for college expenses, there is a 10% additional tax on earnings.

Ordinary income

If not used for qualified expenses, all earnings are taxed as ordinary income (even if the “actual” earnings were capital gains).

Higher costs

The management fees for a 529 account are typically higher than the fees for comparable mutual funds.

Less flexibility in investments

Most investment vehicles can be changed only once per year, and the choices are limited to certain managers.

No discount on gifts

If an individual is choosing between a gift of an asset that can be discounted (such as partial interest in real estate) and a gift to a 529 plan, he/she can transfer “more” through gifts of real estate (which can be discounted).

Decreases ability to reduce estate

  • If you make annual gifts to a child (rather than to 529 account), you can pay college expenses out of your own pocket, and thereby, reducing your estate. Note: In this case, your estate is reduced by annual gifts and by college expenses.
  • If you make annual gifts to a 529 account for a child and pay college expenses from the 529 account (rather than out of your own pocket), your estate is reduced by annual gifts, but not by college expenses.

What does a typical 529 plan funder look like?

The size of your estate

Most 529 plan contributors are moderately wealthy and are not making annual exclusion gifts. There is no estate tax disadvantage to begin funding by using your exclusion and likely you won't need to utilize your lifetime exemption. Further, you get the income tax benefit (assuming funds are used for qualified college expenses), as well as a possible estate tax benefit by reducing your estate value via your annual gifts.

If you're considered "moderate means" and not "high net worth" by definition, you may be more focused on saving for retirement than your child's education. You may not have excess cash flow, therefore, a 529 plan may not be ideal for you.  In addition, a 529 plan may affect your child's ability to qualify for financial aid (federal, state or the educational institution's).

The age of the children

The younger the child, the better; this gives you more time for tax-free accumulation.

Equalization among children

If your goal is to provide equal funding for different beneficiaries, a 529 plan technique should be used with caution. Example: Grandma has given $500,000 to her 10-year-old grandchild and has used her entire lifetime estate and gift exemption (i.e. unified credit) on this and other gifts. Another grandchild is born and now Grandma would like to try to make her gift to this child equal to the other’s gift. While Grandma can use her annual exclusions to contribute $16,000 to each of her grandchildren's 529 plan accounts, there is nothing to prevent Grandma (or whomever controls the account) from directing the entire distribution away from the 10 year-old to the newborn down the road, thereby, breaking the equalization attempt.

How to select the right plan for your family’s needs.

So, you’ve decided a 529 plan is the way to go. Now — how do you select the right one? They’re not all the same, and you don’t have to choose the one your state sponsors. Let’s take a look at the relevant factors.


The first place to look is your home state. As of 2022, 30 states including the District of Columbia, offer special state income tax benefits to their residents, such as a state income tax deduction or tax credit or contributions to the 529 plan of that state. Some states provide lower fees for residents as well2 There are 7 states that provide income tax deductions for contributions to any 529 plan, regardless of location.  They include: Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana and Pennsylvania.


Fees can have a major impact on the performance of a 529 account. You may want to consider lower fee plans. Most generally range from 0.13% to 0.89%. States with plans in this range include Utah, New York, Iowa, Michigan and Nevada.

Choice of funds

While fees are important, different 529 plans have variable funds from which to select. It’s crucial to examine these choices and track record of the funds.

Creditor protection

If creditor protection is a major issue, be sure to review this aspect of each plan. Alaska and New York (and perhaps other states) have special provisions for creditor protection, subject to certain restrictions.

Contribution restrictions

All states have contribution limits ($300,000 and up in most states), and others raise their limits each year to keep up with rising college costs. Some plans also may have a contribution limit, both initially and each year.

Talk with your financial advisor when you’re ready to consider a 529 plan. You’ll have a lot to think about before determining whether a 529 plan is right to finance your children’s education and then finding the plan that’s right for you. Your financial advisor can help you structure a plan that best fits your needs.

1Internal Revenue Code 26 § 529 – Qualified Tuition Programs, enacted in 1996

3 Fee range is approximate, variable by fund and change periodically

Legal disclaimer:

SEI Private Wealth Management is an umbrella name for various wealth services provided through SEI Investments Management Corporation (SIMC), a registered investment advisor. SIMC is a wholly owned subsidiary of SEI Investments Company. Investing involves risk including possible loss of principal.

The material included herein is based on the views of SIMC. Statements that are not factual in nature, including opinions, projections and estimates, assume certain economic conditions and industry developments and constitute only current opinions that are subject to change without notice. Nothing herein is intended to be a forecast of future events, or a guarantee of future results. This presentation should not be relied upon by the reader as research or investment advice (unless SIMC has otherwise separately entered into a written agreement for the provision of investment advice). 

Neither SEI nor its affiliates provide tax advice. IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any matters addressed herein. You should seek advice based on your particular circumstances from an independent tax advisor. The information contained in this communication is not meant to substitute for a thorough estate planning and is not meant to be legal and/or estate advice. It is intended to provide you with a preliminary outline of your goals. Please consult your legal counsel for additional information. This is intended for educational purposes and not meant to be relied upon as investment advice.

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