With college acceptances in hand, your child (or grandchild) is likely contemplating which school to attend, and you may be figuring out how to fund the next four or more years of their education or get the most out of any tax benefits from savings or investment accounts. Even if you don’t have teens yet, you might already be thinking about how to fund future college expenses smartly.
Due to the staggering growth in college costs over the past two decades, funding your aspiring student’s higher education may come up on you quickly, especially if you haven’t planned properly in advance. Applying for financial aid can help with expenses, or you might be able to use savings or existing income streams. You may also qualify for an education tax credit, such as the American Opportunity Tax Credit (AOTC). Additionally, while not a funding plan, you might want to consider schools that allow your out-of-state student to gain residency.
A great savings tool is the tax-advantaged 529 education savings plan. If you don’t already have one, it’s worth considering as this plan allows you to contribute money that will grow if invested properly. If you use funds from the 529 to pay for your beneficiary’s qualified college expenses, the growth on the investments is tax-free.
In this article we explore five ways in which you can optimize a 529 plan or save using an alternative funding method.
1. Know the 529 Plan Tax Advantages
To qualify for tax exemption, 529 plan fund withdrawals can be spent only on certain expenses, such as tuition, books, supplies, computers, printers, and software.¹ Tuition reimbursements are allowed up to $10,000 per year per beneficiary, as well as for student loans at up to $10,000 in a lifetime. Note that this also includes reimbursements for K–12 tuition at private, public or religious schools.
If funds are withdrawn for nonqualified expenses, any earnings are subject to state and federal taxes plus a 10% penalty.2 As of 2024, it may be possible to roll over unused 529 plan funds to a Roth IRA without tax penalty but there are rules for qualifying for this option. You can learn more here: Your Guide to 529 Plan–to–Roth IRA Rollovers.
| Educational expense | Qualified or nonqualified |
| Tuition and fees | Qualified, full amount |
| Books and school supplies | Qualified, for college expenses |
| Computers, software, subscriptions, internet | Qualified, for college expenses |
| K–12 schooling | Qualified; tuition only; limit $10,000 per year, per beneficiary |
| Student loans | Qualified, lifetime limit $10,000 |
| Room and board | Qualified, for enrollment at least half-time; may include meal plan |
| Transportation | Nonqualified |
| Medical expenses | Nonqualified |
| Health insurance | Nonqualified |
2. Superfund a 529 plan
For tax year 2025, you can deposit up to $19,000 per year into a 529 plan for each beneficiary (married couples can double this amount) without filing a gift tax return. This means an individual can contribute up to $95,000 in a single year to one 529 plan and if their spouse also superfunds, it would be a total contribution of $190,000. To superfund your contributions, you can make up to five years of deposits in a single year by filing Form 709 with your federal income tax return.1
3. Use the 529 plan deduction
Some states, like Colorado, offer a state income tax deduction for 529 plan contributions made by residents. When funding college costs with your cash flow rather than savings, it might make sense to first deposit funds into a 529 plan even if you intend to distribute the funds soon afterward. If allowable by your state and plan, you could qualify for a state income tax benefit even if the funds are in the plan for just a short time. You can compare 529 plan deductions or credits for states with an income tax at Saving for College.
4. Prepay tuition with a 529 plan to lock in rates
In addition to the commonly known 529 savings plan, there’s a private college 529 plan available for approximately 300 participating private colleges. The plan allows you to pay tuition at current rates for when a child enters college in the future. Funds are invested and gains are tax-free. Some states may offer tax deductions for contributions. There’s flexibility with the plan so if the beneficiary chooses not to attend one of the private colleges, you can change the beneficiary or roll the funds over into a state-sponsored 529 plan. Some states offer a state-sponsored prepaid tuition plan, but they are less flexible than 529 plans when it comes to qualifying expenses, contribution limits, resident requirements, and more.
5. Plan for multiple generations with a 529 plan
529 plans aren’t just for your children. If your state is one of the more than 30 that allow a state income tax deduction for 529 contributions, it might make sense to contribute to a plan to fund your own higher education at an eligible institution.
What if you fund a 529 plan and the beneficiary doesn’t seek higher education? In that case, you can designate a new beneficiary. There are no income tax consequences for changing the beneficiary of a 529 account if the new beneficiary is a member of the same “family.” The definition of a family member is broad and includes siblings, children, descendants, and cousins.
So-called Dynasty 529 accounts cover college costs for multiple generations but be aware that gift tax rules may apply. There may be less flexibility with a Dynasty 529, as some states may not allow beneficiary or account owner changes for Dynasty 529 plans. There are no age limits or contribution limits for the Dynasty 529, however, these rules could change over the lifetime of the account.
Consider an alternative to the 529 plan
There are cases when you shouldn’t pay for higher-education expenses with a 529 plan. A common example is when you plan to claim the American Opportunity Tax Credit (AOTC), which is a federal income tax credit of up to $2,500 for those who spend $4,000 on qualified college expenses, including tuition, fees, and books.3
Getting more than 60% of higher-education costs refunded is a remarkable benefit, but a caveat is that you cannot use a withdrawal from a 529 plan for an expense that will qualify for the AOTC. Keep in mind that the full AOTC is available only to those who have a modified adjusted gross income (MAGI) of $80,000 or lower, with married couples having a limit of $160,000. The same rules for double dipping apply to the Lifetime Learning Credit (LLC), which can be up to $2,000 per tax return.
If you’re likely to qualify for either the AOTC or LLC, you’ll probably want to pay for at least some higher-education expenses with funds outside of a 529 plan. It might even make sense for your student to take out a federal student loan, if needed, to qualify for one of these generous credits.
Take action
Whether you’re a parent or grandparent, taking action to plan for college expenses is critical given the high costs involved. Starting to save as early as possible is ideal but there are other ways to fund higher education if you have a comprehensive financial plan. It’s important to understand how the 529 plan works and research which options have low costs and diversified investment options to determine if it’s the right savings vehicle for you and your family. If your state offers a tax advantage for 529 plan contributions, make sure your chosen plan qualifies. Talk to your wealth advisor to learn more about identifying the right plan for you and your family.
Not a Mercer Advisors client and want to know more about saving or paying for college? We offer a family office for your family, which means we can manage all your financial and investment needs through an integrated approach to financial planning, investment management, tax, estate, insurance, and more. If you want to move further toward achieving your financial goals, let’s talk.
1 “529 Plans: Questions and answers.” IRS, 31 Jan. 2025.
2 “The Schwab 529 Education Savings Plan.” Charles Schwab, 31 Jan. 2025.
3 “American Opportunity Tax Credit.” IRS, 31 Jan. 2025.
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