The Pros and Cons of 529 Plans & Education Savings Accounts

When it comes to saving for future education costs, 529 plans are often the first option people think about. These unique accounts are designed to encourage saving specifically for educational expenses, offering potential tax advantages along the way. But like any financial tool, 529s aren’t a perfect fit for everyone. Understanding both the pros and cons of 529 plans can help you decide whether this type of account makes sense for your family’s situation and education goals.

The Benefits of 529 Plans

1. Tax-Advantaged Growth Perhaps the biggest draw of a 529 plan is the tax treatment. Earnings in the account grow tax-deferred- meaning that they aren't taxed until they'e withdrawn- and withdrawals are tax-free when used for qualified education expenses such as tuition, fees, and even some K–12 tuition and supplies. The list of qualified expenses was expanded further by the One Big Beautiful Bill legislation passed in July. This tax-deferred- and potential tax-free- treatment means that more of your money stays invested and working for you over time.

2. State Tax Incentives Many states sweeten the deal by offering a state tax deduction or credit for contributions. This upfront tax break can make a big difference, especially to offset the growing cost of education families are facing today. The tax benefit varies by state, so check your home state's law to best understand any tax savings opportunities available to you.

3. High Contribution Limits and Control Unlike some accounts with low annual caps or income limitations, 529 plans typically allow very large contributions over time, making them useful for parents, grandparents, and even extended family who want to pitch in. The account owner, not the beneficiary, remains in control of the funds, meaning you decide when and how the money is invested and eventually used.

4. Flexibility Across Beneficiaries If one child earns a scholarship or chooses not to attend college, the beneficiary can be changed to another qualifying family member. This reduces the risk of money going unused if plans change in families with multiple children.

5. New Bonus Consideration: A Future 529 → Roth IRA Rollover Perhaps the most exciting recent development is a new rollover opportunity introduced by the SECURE 2.0 Act, effective as of 2024. The new (ish) law makes it possible to roll unused 529 funds over to a Roth IRA, up to a Lifetime Rollover Limit of $35,000 per beneficiary, tax- and penalty-free. There are a handful of caveats to this planning opportunity worth calling out: the account must be open for at least 15 years, the funds being rolled over must have been in the 529 account for at least 5 years, the beneficiary must meet the standard earned income rule, and, notably unlike regular rollovers, the rollover limit cannot exceed the regular Roth IRA contribution limit set by the IRS ($7,000 in 2025 for most folks, adjusted annually for inflation).

The Pitfalls of 529 Plans

1. Limited Use of Funds The biggest downside of a 529 is the restriction on qualified expenses. Withdrawals for anything other than education typically incur both taxes and a 10% penalty on the earnings portion. While there are a few exceptions, such as limited student loan repayment, the account is still relatively narrow in purpose. Particularly because planning projections tend to lean conservative, the risk of overfunding a 529 is rather high.

2. Market Risk and Investment Options Like other investment accounts, 529 plans are subject to market ups and downs. Additionally, your investment choices are usually limited to a set menu offered by the plan administrator, similarly to an employer-sponsored retirement plan, which may not align perfectly with your investing allocation preferences or broader portfolio strategy.

3. Financial Aid Considerations 529 accounts are considered parental assets on the FAFSA, which means they can slightly reduce a student’s eligibility for need-based aid. While the impact is usually modest compared to assets held in the student’s name, it’s still worth factoring in.

Alternatives to Consider

One thing we can all agree on is that education is expensive, and starting early is so important!

While 529s can be excellent tools, they aren’t the only way to save for education. Some families prefer saving into a Roth IRA, or even a Mega Backdoor Roth, which allows for retirement savings but also permits penalty-free withdrawals of contributions for education if needed. Roth IRAs let you withdraw contributions (but not earnings) penalty-free even for education—offering multi-goal flexibility beyond retirement, though they do require annual earned income and have fairly low annual limits.

Others may choose a taxable brokerage account, which offers maximum flexibility; funds in a taxable brokerage account can be withdrawn anytime and used for education, retirement, a first home, or any other goal, all without penalties. Taxable Brokerage Accounts offer all the investment and withdrawal flexibility plus varied investment options, but, they lack tax-deferral, tax-free growth opportunities, or plan-specific incentives.

Final Thoughts on the Pros and Cons of 529s

A 529 plan can be a powerful education savings tool, especially if you live in a state that offers a tax deduction or credit for contributions. However, the account’s restrictions and potential penalties mean it’s not always the best option for everyone. Balancing education savings with other priorities, like retirement, is critical. For many families, a mix of accounts may strike the best balance. Work with your advisor to determine the right savings amount and accounts for your family's needs.

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📌 Sage Financial Planning LLC is a California RIA providing values-based financial planning and financial advice in San Diego, CA and nationwide via virtual platforms. Sage Financial specializes in serving First Generation Wealth Builders who want to change their financial family trees for the better, as well as values-based clients who want to not only achieve financial security and freedom for themselves, but who want to support their communities in meaningful ways and leave the world better than they found it.

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