A Rare Tax Break for the Wealthy: The 529 Account

Welcome to another excellent Saturday Selection, a series in which a classic (but updated) post from a member of the WCI Network is shared with you.

Today’s guest author is none other than the White Coat Investor himself. Since the original publication, tax reform has given 529 Plans a new use, since you can now withdraw up to $10,000 a year per beneficiary to pay for private and parochial K-12 school tuition.

Our boys go to public schools, so we have no plans to use ours until college, but we’ve already funded the two 529 Plans generously, having crossed over into six-figures for each of them recently.

This post originally appeared on The White Coat Investor, and he recently wrote about them again in Am I Done Saving for College?

Tax Break for the Wealthy – The 529 Account


This is another one in my series of Back to Basics posts.  I find many physicians, dentists, and trainees have never been taught many of the basics of investing and financial planning, so posts like this are designed to fill in the gaps.

529s are a critical part of the four pillars of paying for college. 529s are named after a section of the tax code, just like 401Ks.  Stupid, I know, but that’s the way these things work.  What they should have been called was The Tax Break For The Rich, because that’s what they are.  Or at least, the tax break for the high-earners, which isn’t necessarily the same thing as the tax break for the high-net-worthers.  Why is it the tax break for the rich?  We’ll get to that, but first, the basics.

529 College Savings Plan


A 529 plan is a state-sponsored way to help you save for your kid’s college.  Basically, you put after-tax money into it, then it grows tax-free, and if spent on legitimate college (or med school) [or high school as of 2018-ed] expenses, it comes out of the account tax-free.  You can put up to $15K a year in therin 2018.

Each state has their own plan (or two), and some are better than others.  Sometimes you also get a break on your state income taxes if you use the one in your state.  The expenses of the plans, like 401Ks, vary quite a bit, and change often.  You can move money from one 529 to another fairly easily, much like transferring an IRA from one custodian to another.

The 529, unlike a UGMA, isn’t your kid’s money.  It’s yours.  So you can take it out and spend it on a boat if you like (but you’ll have to pay a 10% penalty, plus your regular income taxes on the earnings.)

You can also roll it over from your daughter’s 529 to your son’s 529 to your grandson’s 529 without any penalties, which gives you a lot of options when Junior decides to smoke dope and play disc golf professionally instead of going to Yale like you planned when he was three. Be aware that the “generation-skipping tax” only applies if the new beneficiary is two or more generations away from the old beneficiary and only applies if the transfer exceeds the gift tax exemption amount.

If your state doesn’t have any income tax, or if it doesn’t give a break for 529 contributions, or if its expenses are ridiculously high, you may want to look into the best 529s out there.

Since the plans change often, so does this list, but I would consider looking into the plans from perennial front-runners Utah, Nevada, and New York.  Compare investment options, plan expenses, and expense ratios of the various funds.  Some states offer a pre-paid tuition type plan.  Basically, you pay tuition at today’s price and the state takes the risk of tuition inflation.  Given the past rate of inflation, that might be a pretty good investment, but be aware that the deal may be different for in-state schools versus out-of-state schools, unlike the more standard “defined contribution” 529s.

529 plans do count against a kid if he’s trying to get financial aid.  Thanks to a 2009 law, a 529 in either your name or your child’s name has an expected family contribution of 5.64%. (Consider having the grandparent own the account if this is an issue, but honestly, most readers aren’t going to qualify for any sort of financial aid anyway.)

Now, Why is the 529 a Tax Break for the Wealthy?


Several reasons:

1) High Contribution Limit


An Educational Savings Account/Coverdell/Education IRA works just fine for those who don’t make much.  In fact, you can use it for high school expenses as well as college [Update: You can do this with 529s as of 2018]  and it can offer lower expenses and more investment choices than a 529.

You don’t get a state tax break with an ESA, but the working class doesn’t pay all that much in income taxes anyway.  The problem with an ESA is that you can only put $2K a year into it.  That just isn’t enough to pay cash at Harvard.  This isn’t an issue for the working class.  It’s hard enough to put $2K into that account for each of their kids.  But for a high-earner, it’s nice to have the higher contribution limit ($15K/year) of the 529.


2) State Tax Breaks


My state allows both me and my wife to put $1,960 EACH [$3920 joint in 2018 – Ed] into a 529 for EACH of our children and get a credit for it on our state taxes.  That’s the equivalent of a $16K deduction off my state taxes, which saves me about $800 a year.  Tax break going in, tax break while growing, tax break coming out.  Can’t beat that.


3) Lump-Sum Contribution


Would you like to shelter MORE than $15K per child, per parent, per year?  You can.  You’re allowed to front load up to 5 years worth of contributions at one time, up to $150K per child.  Eventually, there’s a limit on contributions, usually somewhere around $300K to $500K per child, but it varies by state.

Imagine putting in $150K in when your child is born, $150K when your child turns 5, $150K when your child turns 10, and another $90K when your child turns 15.  By the time he turns 18, assuming 8% returns, you’ll have well over a Million for college.  I don’t care what tuition inflation is, that’s going to cover it.  Obviously the poor can’t do this, but the rich can. [PoF edit: Many plans won’t allow you to contribute further once the balance reaches the cap, but further growth via returns from the funds the balance invested in is typically allowed.]


529 tax break

a couple of 529 hundred-thousandaires


4) College Savings


The working class pays for college by working their way through it and taking loans.   They’re doing well to put away $15K for retirement, much less for their kid’s college.  They simply don’t have a need for a 529 plan. As a general rule, only high-earners have a little extra to put away for the next generation.


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Should the High Earner Overcontribute to a 529?


Now, for the advanced reader, a discussion of whether you should purposely overcontribute to a 529.  Let’s say you’ve maxed out your IRAs, 401Ks etc.  You’ve got more money to save, but are already saving plenty for college.  Should you put even more into 529s planning to take it out later and spend it during retirement?

Let’s analyze how you’ll end up.  First, some assumptions.  Let’s assume you get a 5% tax break on your contributions, that your investments earn 8%/year, and that you pull the money out 30 years after you put it in.

Let’s further assume that your state DOESN’T recapture the state tax breaks you got years earlier when you contributed it.  (Some do recapture these.)  We’ll also assume you invest in a relatively tax-efficient investment such as a stock index fund, and that the 529 expenses are 0.3% higher than they would be in a taxable account and that your total marginal tax rate when you withdraw the money is 30% and your total capital gains tax rate is 15%.

Let’s compare investing in the 529 with a taxable account.


$10,000 into a 529

Instant 5% return= $500

After 30 years, $10,500 invested at 7.7% (reduced for 529 expenses) grows to $97,199. 30% taxes plus 10% penalty reduces this to $58,319.


$10,000 into a taxable account

After 30 years, $10,500 invested at 7.7% (reduced for capital gains/dividends of 2%/year taxed at 15% rate) grows to $97199.  You now sell it at 15% capital gains rates with no penalty, leaving you with a total of $82,619.

Now, you might have to pay a little more in taxes in the taxable account if you churn your account, but you also might have opportunities for tax loss harvesting, charitable donations, etc… to reduce your tax burden.  (See my article on Taxable Accounts for more details.)

It’s pretty clear that investing in a 529 for reasons other than education isn’t very bright.  If you do mistakenly over-contribute, you can always roll it over to another family member’s 529, but you certainly shouldn’t be trying to game the system by purposely over-contributing for your retirement. Over-contributing in order to start a college fund for a grandchild is another matter, of course, as is over-contributing in order to roll it into an ABLE account for your disabled child.

In summary, a 529 is a great way to save money on your taxes and help Junior avoid the loan burden you probably had to deal with.  As tuition continues to skyrocket, even state school undergraduate degrees may soon be out of reach of those who can’t pay at least part of the bill using savings.


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[Update:  Consider reading  Morningstar’s 2017 Analyst rankings of the best 529 Plans here. – Ed]

If you have children, do you fund 529 Plans? Do you have a target dollar amount? Let’s discuss below.




  • W. Daily

    Thanks for the great article. As my child opted to go to an in state public university, I will have about $50K left in the 529 when she graduates. Could I transfer the account to myself if I wanted to take a University course in Italian history in Florence, Italy? Assuming I can, does the entire amount have to be transferred or could a portion be transferred to my wife and she would take an art course in Florence?

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  • A lot of people contribute monthly or annually. It is fine to get the annual tax credit if your state offers one. Otherwise, the math works out for an early lump-sum investment to give you a better tax benefit than a steady investment over time. Most “average workers” can’t afford this so they pay as they go. A lot of doctors could afford to pay in early though. I learned this from a Joshua Sheats podcast.

  • S coggins

    Your calculations do not take into account the returns when a person actually uses the 529 for its intended purpose at retirement. Most physicians go into medicine expecting to be lifetime learners so if like me you contribute to a 529 for yourself and spouse to actually use the account as intended it’s a great investment tool. Not only can you use the money for school expenses but also for living expenses up to the amounts prescribed by federal guidelines for a students average living expenses while enrolled tax free. If your lucky the local schools give senior citizens tuition reductions and make your actual costs for school quite low and still allow full living expense withdrawals from the 529. It requires the student to be enrolled full time but there are many courses that I’m looking forward to take for self fulfillment. Certainly the opportunity to study abroad paid with a 529 account is another great idea for the retired physician.

  • I didn’t use 529 accounts as the state university costs could have been easily cash flowed but as it turned out my three millennial kids all got 100% free ride academic scholarships. I have no interest in being a full time paid student in retirement considering there is unlimited free/cheap educational material available now on the internet. I also don’t have any grandkids and would not pay their schooling if I did as that might be harmful to my kids. I suppose in a case like mine I could have gotten the money back by paying a 10% penalty and taxes on any gains?

  • Dan Griffin

    Yep — my concern is over-contributing — especially when paired with how I’m hoping to help my kids “hack” the typical path using CLEP, dual enrollment, and similar. There are caveats that let you withdraw penalty free in the case of the a scholarship. But no such rules exist just for underspending. So I’ve decided to pause my 529 contributions for the foreseeable future.

  • L

    As someone pointed out earlier – indeed having a 529 for yourself is a great investment tool in case you want to pursue further education (at any time). Plus a child can be added as a beneficiary anytime.

  • In our case they arent really for the rich – our state North Dakota plan is among the highest expenses for 529 and our state taxes are among the lowest so we saved money by using the Utah plan through Vanguard. Would have done the same if we werent high earners.
    We dont overfund, plan on having 100K by 10 year bdays and taking it from there, chose the aggressive glide path because we dont need the 529 so put it at risk knowing we’ve started funding young. Best 60K (so far) weve spent. We get more satisfaction looking at the 529 balances than our brokerage, and the brokerage = FIRE!

  • jp

    one thing that i haven’t found addressed anywhere: can you set up a 529 account and receive the tax break for a child that is NOT yours? i.e. our friends are having a baby, we are the godparents, can we set up a 529 for this kid under our names and get the tax break? We don’t want to put the child’s name as owner, as they will have direct access to all funds, and we aren’t 100% sure the parents would use the funds as intended (i.e. while we would pay for a class in underwater basket weaving – how awesome of a class would that be!? – we don’t necessarily want to pay for a degree in it)

  • Steve

    How are 529 plans inherited? If my daughter doesn’t use all the funds and we change the beneficiary to her son (my grandson), could my daughter inherit the 529 and fund my grandson’s education?

  • Xrayvsn

    I have a few questions on the front loading option:

    1) Do you have to do all 5 yr front loading at once or can it be done partially (say 2 or 3 yrs)
    2) If it is done partially do you have to wait till that front loading time period has passed or can you do the same the very next year as long as it amounts to the initial 5 yr front load (ie in year one can you pay 3 yrs ahead and year 2 pay 2 yrs for a total of 5)
    3) What happens if you front load all 5 yrs and then tax change increases the annual amount of gift that can be given (which happened for 2018 raising it to 15k from 14k). Are you allowed to put the extra in for the years you front loaded at the lower amount?

    And on a separate note, are there any good guidelines of what balance you should have in a particular child’s account based on his or her age? It would be nice to compare where I am at with my child (I believe I have around $66k and she is in the 7th grade

    Also I am currently single so I don’t have the benefit of doubling the amount to my daughter’s account that a married couple has but I was thinking of “cheating the system” this way:

    Since I am allowed to gift 15k to anyone without tax implications, is it possible to first contribute to my daughter 529 using up that gift amount and then gift my mother (her grandmother) the same amount and then she can then later turn around and gift it as a separate 529 contribution back to my daughter (she doesn’t have the finances to do it herself). My theory why this would work is I am allowed to gift to my mother and that money becomes hers and she can do whatever she wants with it but would put it in 529 for my daughter as her own gift (which was my original intention with this money)

    Lastly when you gift this amount for 529 is that something there is a line you report in your taxes for (similar to establishing a basis in a non deductible ira (believe form 8606)? And do you have to indicate that you are giving a gift up to limit on your tax return? (this is first yr attempting my own taxes)


  • Nightnightdoc

    I had a question, that I hope folks can shed some light on.

    What would you say is a good amount to contribute each year per child if you wanted to not only pay for college but 4 additional years of graduate school. I had the amazing blessing of having my medical school paid for, however with the expectation that I do the same for my children.

    I realized that the 529 not only can pay for tuition but also for housing, books etc. So I’m unsure how much I should save into this account. I want to put a decent amount in, but as described earlier I’m not looking to use the 529 as a tax shelter where I could potential place the money in a taxable account to grow.

    I also realize that it greatly depends on whether my children go to a instate public vs private college. But lets assume my kids go to a public college not one that cost 50k/year. I’m leaning to 5-6K per year per kiddo. What would the FIRE community recommend.

    Thank you for any insight that you may provide.

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