Tax-Preferred College Savings Plans: An Introduction to 529 Plans

Tax-Preferred College Savings Plans: An Introduction to 529 Plans

Tax-Preferred College Savings Plans: An
February 27, 2024
Introduction to 529 Plans
Brendan McDermott
Among the options families may choose to save for education (elementary and secondary as well
Analyst in Public Finance
as higher education), they may consider using tax-advantaged qualified tuition programs (QTPs),

also known as 529 plans.

529 plans, named for the section of the Internal Revenue Code (IRC) which dictates their tax
treatment, are tax-advantaged investment trusts used to pay for education expenses. The specific tax advantage of a 529 plan
is that distributions (i.e., withdrawals) from this savings plan are tax-free if they are used to pay for qualified higher-
education expenses. In addition, up to $10,000 per beneficiary per year can be withdrawn and used for qualifying K-12
education expenses. If some or all of the distribution is used to pay for nonqualified expenses, then a portion of the
distribution is taxable, and may also be subject to a 10% penalty tax.
There are two types of 529 plans: “prepaid” plans and “savings” plans. A 529 prepaid plan allows a contributor (i.e., a parent,
grandparent, or nonrelative) to make lump-sum or periodic payments that entitle the beneficiary to a specified number of
academic periods, course units, or a percentage of tuition costs at current prices. A 529 savings plan allows contributors to
invest in a portfolio of mutual funds or other underlying investments.
While prepaid 529 plans were the first type of 529 plan established, savings plans have grown in popularity and are now the
most common type of 529 plan. There are currently 17 prepaid 529 plans offered, in contrast to 94 savings plans. In addition,
according to the most recent data, of the $432 billion worth of assets in 529 plans as of September 2023, 95% ($409 billion)
were held in savings plans, while 5% ($23 billion) were held in prepaid plans.
This report provides an overview of the mechanics of 529 plans and examines the specific tax advantages of these plans.
Specifically, this report is structured to first compare “savings” and “prepaid” 529 plans and, second, to examine the income
and gift tax treatment of 529 plans, using a stylized example to illustrate key concepts. The report also examines the tax
treatment of rollovers and the interaction of 529 plans with other education tax benefits and looks at how 529 plans are
treated in the federal needs analysis for financial aid. Finally, the report summarizes recent legislative changes.
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Contents
Introduction ..................................................................................................................................... 1
Overview of 529 Plans .................................................................................................................... 1
Types of 529 Plans: Prepaid and Savings Plans .............................................................................. 2
Tax Treatment of 529 Plans ............................................................................................................. 5
Income Tax Treatment ............................................................................................................... 7
Contributions ...................................................................................................................... 7
Distributions ........................................................................................................................ 7
Calculating the Taxable Portion of a 529 Distribution: A Stylized Example ...................... 8
Interaction with Other Education Tax Benefits ......................................................................... 9
Rollovers and Transfers ........................................................................................................... 10
To Another 529 Plan ......................................................................................................... 10
To an ABLE Account ........................................................................................................ 10
To a Roth IRA ................................................................................................................... 10
Gift Tax .................................................................................................................................... 11
Interaction of Assets and Distributions from 529 Plans with Federal Student Aid ........................ 11

Figures
Figure 1. Calculating the Taxable Portion of a 529 Distribution: A Stylized Example ................... 9

Tables
Table 1. Comparison of 529 Prepaid and Savings Plans ................................................................. 4

Contacts
Author Information ........................................................................................................................ 13

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Tax-Preferred College Savings Plans: An Introduction to 529 Plans

Introduction
Families may choose to save for college or elementary and secondary education expenses using
tax-advantaged qualified tuition programs (QTPs), also known as 529 plans. This report provides
an overview of the mechanics of 529 plans and examines the specific tax advantages of these
plans. For an overview of all tax benefits for higher education, see CRS Report R41967, Higher
Education Tax Benefits: Brief Overview and Budgetary Effects, by Margot L. Crandall-Hollick
and Brendan McDermott.
Overview of 529 Plans
529 plans, named for the section of the tax code which dictates their tax treatment, are tax-
advantaged investment trusts used to pay for education expenses. The specific tax advantage of a
529 plan is that distributions (i.e., withdrawals) from this savings plan are tax-free if they are used
to pay for qualified higher education expenses. In addition, up to $10,000 may be withdrawn tax-
free per beneficiary per year and used for qualifying elementary and secondary school expenses.
Any distribution used to pay for nonqualified expenses is taxable and may also be subject to a
10% penalty tax.1 (A description of qualified and nonqualified expenses is provided later in this
report.)
Generally, a contributor, often a parent, establishes an account in a 529 plan for a designated
beneficiary, often their child.2 Upon establishment of a 529 account, an account owner, who
maintains ownership and control of the account, must also be designated. In many cases the
parent who establishes the account for their child also names herself or himself as the account
owner.
According to federal law, contributions to 529 accounts must be made in cash using after-tax
dollars.3 Hence, contributions to 529 plans are not tax-deductible on federal income taxes to the
contributor. The contributor and designated beneficiary cannot direct the investments of the
account, and the assets in the account cannot be used as a security for a loan. A contributor can
establish multiple accounts in different states for the same beneficiary.4 Contributors are not
limited to how much they can contribute based on their income. With respect to higher-education
expenses, beneficiaries are not limited to how much they can receive based on their income. With
respect to elementary and secondary school expenses, beneficiaries can withdraw the amount of
their K-12 tuition expenses up to $10,000 tax-free from a 529 plan. (This limit applies to all
accounts, not each account.) However, each 529 plan has established an overall lifetime limit on
the amount that can be contributed to an account.5

1 The tax will be paid by either the beneficiary or the owner of the 529 plan account.
2 The individual who maintains and controls the 529 account may not necessarily be a contributor. For example, a
grandparent (contributor) could establish a 529 account for their grandchild (beneficiary), but have the child’s parents
be the account owners who maintain and control the account.
3 This can include checks, money orders, and credit card payments. Payments cannot be made in the form of securities.
4 For example, an account can be established for beneficiary X in state A’s 529 plan, and an account can be established
for beneficiary X in State B’s 529 plan. These two plans for beneficiary X can be established by the same contributor or
different contributors.
5 IRC §529 (b)(6) does require that 529 plans limit the amount of contributions to an amount “necessary to provide for
the qualified higher education expenses of the beneficiary.” For more information, see
https://www.savingforcollege.com/compare-529-plans/maximum-contributions.
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Tax-Preferred College Savings Plans: An Introduction to 529 Plans

Types of 529 Plans: Prepaid and Savings Plans
There are two types of 529 plans: “prepaid” plans and “savings” plans. A 529 prepaid plan allows
a contributor (i.e., a parent, grandparent, or nonrelative) to make lump-sum or periodic payments
that entitle the beneficiary to a specified number of academic periods, course units, or a
percentage of tuition costs at current prices. Essentially, the contributor is paying for and
purchasing a given amount of education today which will be used by the student in the future,
providing a hedge against tuition inflation. For example, in 2010 a contributor could have
purchased two years of community college education through a prepaid plan for $5,000. Even if
the price doubled by the time the beneficiary attended community college, they would have
already paid the tuition in 2010.
Generally, a prepaid plan is used to purchase education at a public in-state institution.6 Prepaid
plans are established and maintained by a state or a state agency or by an educational
institution.7,8 Prepaid plans tend to have certain restrictions in terms of the expenses they cover,
residency requirements, and eligible educational institutions. In some states, the value of these
plans is backed by the full faith and credit of the state government, implying that the state bears
the risk of the account performance, not the account holder. In addition, some prepaid plans are
closed to new beneficiaries, meaning a family cannot open an account in the plan.
A 529 savings plan allows contributors to invest in a portfolio of mutual funds or other underlying
investments.9 Contributors can make periodic investments directly in the plan, with the ultimate
value of these accounts determined by the performance of the underlying investments. In
addition, 529 savings plans can be purchased directly from a plan manager (“direct sold”) or
purchased through financial advisers (“broker sold”). Unlike prepaid plans, the amount of
education which can ultimately be purchased using a savings plan is not guaranteed. Instead, the
amount of education that can be purchased depends on both the cost of education and the
performance of the underlying assets in the 529 savings plan. In addition, the value of savings
plans is not limited to tuition at in-state public institutions. Savings plans are established and
maintained by a state or a state agency, but tend to be less risky for the state to administer because
their value is typically not guaranteed by the state.10
While prepaid 529 plans were the first type of 529 plan established, savings plans have grown in
popularity and are now the most common type of 529 plan. There are currently 17 prepaid 529
plans offered, only 7 of which accept new accounts and contributions, in contrast to 94 savings
plans.11 In addition, according to the most recent data, of the $432 billion worth of assets in 529

6 While all 529 distributions can be used to pay for out-of-state colleges, most prepaid plans provide the greatest
benefits for in-state colleges. If a student who has a 529-prepaid plan chooses to go to either an in-state private
institution or an out-of-state public institution, the prepaid benefits will be set at the equivalent level of public in-state
tuitions, with many prepaid plans using a weighted-average credit hour value of in-state public institutions. In addition,
the value of the prepaid benefits for out-of-state and private institutions is limited to the lesser of the value of in-state
tuition and fees or the actual tuition. Hence, if the tuition paid at an out-of-state institution is less than in-state tuition,
the student will not receive a refund for the difference.
7 Currently, there is one prepaid program operated by an educational institution—the Private College 529 Plan. See
https://www.privatecollege529.com/OFI529/.
8 States can hire outside vendors like TIAA-CREF, Merrill Lynch, or Fidelity to manage investments and
administrative duties.
9 For example, a portfolio of equities and bonds whose percent composition changes automatically as the beneficiary
ages, a portfolio with fixed shares of equities and bonds, or a portfolio with a guaranteed minimum rate of return.
10 Similar to prepaid plans, states can hire outside vendors to manage investments and handle administrative duties.
11 College Savings Plan Network, 529 Plan Data, September 30, 2023, http://www.collegesavings.org/529-plan-data/;
Flynn, Katherine, “Your Guide to 529 Prepaid Tuition Plans,” Saving for College, November 14, 2023.
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plans as of September 2023, 95% ($409 billion) were held in savings plans, while 5% ($23
billion) were held in prepaid plans.12
There are a variety of differences between savings plans and prepaid plans which may explain the
increased popularity of savings plans. States may be more inclined to offer savings plans because
they may be less costly or risky for states to run. Many states back prepaid plans with their full
faith and credit. In these cases, states must provide a guaranteed benefit to beneficiaries of 529
prepaid plans, even if they do not have sufficient funds in the state’s 529 trust to pay for
beneficiaries’ college expenses. Hence, these plans can be riskier for states to sponsor.13 In fact,
one of the first 529 prepaid plans established, the Michigan Education Trust (MET), had to close
to new beneficiaries shortly after starting because “the program administrators had relied on
overly optimistic projections of the rate of return on invested funds in relation to the trust’s
obligation to pay for rising tuition prices. Simply put, the trust was headed toward insolvency.”14
Savings plans may also be more common because they are more popular with students and their
families. Savings plans generally can be used for more types of expenses at a wider variety of
institutions than prepaid plans, making them attractive to parents who may not know where their
child will ultimately go to college or how much it may cost.15 In addition, prepaid programs
generally require that either the account owner or beneficiary meet state residency requirements,
limiting who can ultimately invest in these plans. The majority of savings programs are open to
contributors and beneficiaries irrespective of their residency.
Notably, while there are many differences between prepaid and savings plans, the tax treatment of
these plans (which will be described later in this report) is identical. Hence, there is not a greater
tax benefit per dollar saved associated with one plan rather than another. Contributors may
compare other features of these plans detailed in Table 1 when deciding which plan is the most
appropriate type for their needs.16

12 Ibid.
13 In spite of the greater popularity of savings plans, prepaid plans tend to be less risk for parents than savings plans.
Unlike 529 savings plans, the purchasing power of prepaid plans is guaranteed. In other words, if you purchase one
semester of education at today’s prices, you will be able to purchase one semester of education when the child attends
college.
14 Joseph F. Hurley, The Best Way to Save for College: A Complete Guide to 529 Plans 2011-2012 (Pittsford, NY: JFH
Innovative LLC, 2011), p. 12. The program later resumed and is again operational after adjusting its pricing.
15 Andrew P. Roth, “Who Benefits from States’ College Savings Plans?” Chronicle of Higher Education, January 1,
2001.
16 Contributors may also look at other attributes of the plans which are specific to each plan, including the fees
associated with each plan, when deciding the most appropriate 529 plan.
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Table 1. Comparison of 529 Prepaid and Savings Plans

Prepaid
Savings
Number
17
94
Qualified
Generally, these accounts cover tuition and
Qualified distributions can be used for tuition
Expenses
required fees at undergraduate institutions.
and required fees, room and board (capped),
books, supplies, equipment, and additional
expenses of special needs beneficiaries at higher
education institutions, as well as fees, books,
supplies, and equipment required for
participation in a registered apprenticeship.

In addition, up to $10,000 can be withdrawn for
a given beneficiary in a given year and used for
tuition expenses at elementary or secondary
schools.

Holders can also withdraw up to $10,000 to
make student loan payments for the qualified
beneficiary.
Residency
Account owner or beneficiary generally has
Account owner or beneficiary generally does
Requirements
to meet state residency requirements.
not have to meet state residency requirements,
although more favorable benefits (state tax
deductibility, matching) may be provided to in-
state residents.
Institutional
In-state public institution (if used for out-of-
Varies from plan to plan, but generally available
Limitations
state school, the amount is generally limited
for a wide variety of public and private higher
to in-state tuition and fees at public
education institutions nationally. (Any eligible
institution).
educational institution meeting Federal Title IV
requirements.) K-12 institutions include public,
private, and religious schools.
Rol overs
Not applicable.
Holders can rol funds from a 529 plan into an
ABLE account. They can also rol up to $35,000
into a Roth Individual Retirement Account,
provided the beneficiary has held the account
for at least 15 years, and annual rol overs
exceed neither the amount contributed within
the last 5 years (and earnings thereon) nor the
annual IRA contribution limit.
Refund
If not all of the amount is used by the
An amount not used can be taken out as a
student, contributors can request a refund,
nonqualified distribution. The amount
although the refund amount is determined
withdrawn as a refund is ultimately determined
by the 529 plan.
by plan performance.
Distributions
Directly to institution.
Beneficiary or account owner or directly to
Go To
institution.
Time
Most prepaid plans can only be used for a
Generally, there is no program-imposed limit on
Limitation
limited duration, generally a given number
how long the account may remain open (as long
of years from the beneficiary’s expected
as the beneficiary is living).
matriculation date.
Participation
Generally, yes. Each year, contributors must No.
limited to an
purchase future col ege education during a
enrol ment
given enrol ment period. Prices are adjusted
period?
annually before each enrol ment period.
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Tax-Preferred College Savings Plans: An Introduction to 529 Plans

Prepaid
Savings
Who Bears
In some states, the plans are backed by the
Contributors bear the risk because the
Risk?
ful faith and credit of the state government, performance of the plan is determined by the
meaning the state bears the risk.
performance of the underlying assets.
Sources: IRC §529; Internal Revenue Service, Publication 970: Tax Benefits for Education, 2011,
http://www.irs.gov/pub/irs-pdf/p970.pdf; Joseph F. Hurley, The Best Way to Save for College: A Complete Guide to
529 Plans 2011-2012 (Pittsford, NY: JFH Innovative LLC, 2011); text of P.L. 115-97; and the Col ege Savings Plan
Network.
Tax Treatment of 529 Plans
As previously mentioned, the specific tax advantage of a 529 plan is that the withdrawals from
these plans are excludable from gross income, and hence not subject to the income tax, if they are
used to pay for certain education expenses incurred in a given year. These expenses are referred to
as adjusted qualified education expenses (AQEE—see shaded text box below). Any amount
withdrawn from a 529 account which does not go toward these expenses is subject to income
taxation and may be subject to an additional 10% penalty tax.
Glossary of Selected Terms
Account Owner: The person with ownership and control of the 529 account. This individual is usually a
contributor to the account.
Basis: The sum of all the cash contributed or paid into the account. It does not include investment returns.
Designated Beneficiary: The individual for whom the account is established.
Distribution: An amount of cash withdrawn from a 529 account (or in the case of prepaid plans, the value of the
education benefits paid by the plan).
Earnings: The total account value minus the basis.
Logically, a taxpayer who receives a 529 distribution (often the beneficiary or the account owner)
would seek to minimize their income tax liability by withdrawing just enough money from their
529 account to cover AQEE and no more. However, this is not as straightforward as it may seem
due to a variety of factors, including the availability of other education tax benefits and student
aid.17 In order to understand the complex decisions taxpayers must consider when determining the
amount of money they should withdraw from a 529 plan, this section details the income tax
treatment of 529 distributions, including the definition of AQEE; when 529 distributions may be
taxable; and the interaction of 529 distributions with other education tax benefits. (An overview
of basic gift tax rules is also included.)

17 Timing issues may also introduce more complexity. Specifically, education expenses are incurred over an academic
year, which does not correspond with a tax year (tax years are generally calendar years).
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Adjusted Qualified Education Expenses
Adjusted qualified education expenses include certain higher education expenses and K-12 expenses.
Higher Education
Qualified higher education expenses are expenses related to enrol ment or attendance at an eligible
postsecondary institution and include any of the fol owing (or combination thereof):18
•
tuition, fees, books, supplies, and equipment required for enrol ment or attendance of the beneficiary at an
eligible educational institution;
•
expenses for special needs services incurred in connection with enrol ment or attendance of a special-needs
beneficiary at an eligible educational institution;
•
room and board expenses for students enrol ed at least half-time19 at an eligible educational institution;20 and
•
fees, books, supplies, and equipment required for an apprenticeship program registered and certified by the
Department of Labor or a state apprenticeship agency recognized by the department.
Elementary and Secondary School
Qualified K-12 expenses include up to $10,000 per beneficiary per year for tuition expenses at a public, private, or
religious elementary school.
To determine the amount of adjusted qualified education expenses, qualified education expenses must be reduced by
the amount of any tax-free educational assistance. Tax-free educational assistance includes the tax-free portion of
scholarships and fellowships, veterans’ educational assistance, Pell grants, and employer-provided educational
assistance. They also, in the case of higher education expenses, must be reduced by the value of expenses used to
claim education tax credits (see “Interaction with Other Education Tax Benefits”).
Student Loans
Qualified student loan repayments include payments of principal and interest on student loans eligible for the
student loan interest deduction. Withdrawals of up to $10,000 over the beneficiary’s lifetime qualify. An additional
$10,000 limit applies to qualified student loan repayments of a sibling of the beneficiary. Taxpayers cannot claim
the student loan interest deduction for any interest paid using tax-free withdrawals from a 529 plan.
Rollovers to ABLE Account
Through 2025, account managers can choose to transfer the assets within a 529 plan into an ABLE account for the
beneficiary or the beneficiary’s family member. ABLE accounts are tax-advantaged savings accounts for individuals
with disabilities.21 The withdrawal from the 529 plan would not face any tax or penalty at the time of withdrawal
provided the transfer is completed within 60 days. The rol over applies toward the general contribution limits
applicable to ABLE accounts defined in IRC §529A(b)(2)(B)(i ).
Rollover to Roth IRA
Starting in 2024, some 529 plans can be rol ed over into a Roth Individual Retirement Account (IRA) for the same
beneficiary. These rol overs cannot exceed the amount contributed to the account within the past five years, along
with any earnings on those contributions. They are also subject to the annual contribution limit for Roth IRAs,
which is $7,000 in 2024. There is also a lifetime limit of $35,000 for rol overs from a 529 plan to a Roth IRA. The
distribution must come from a plan “of a designated beneficiary which has been maintained for the 15-year period
ending on the date of such distribution.” Some have expressed concerns about whether those who rol assets in

18 An eligible education institution for purposes of 529 plans is any college, university, vocational school, or other
postsecondary educational institution eligible to participate in a student aid program administered by the U.S.
Department of Education.
19 A student is considered “enrolled half-time” if he or she is enrolled for at least half the full-time workload for his or
her course of study, as determined by the educational institution’s standards.
20 Room and board expenses cannot be more than the greater of (1) the allowance of room and board that was included
in the cost of attendance for federal financial aid purposes for a particular academic period and living arrangement of
the student or (2) the actual amount of room and board charged if the student resided in housing owned or operated by
the eligible educational institution.
21 For more, see CRS In Focus IF10363, Achieving a Better Life Experience (ABLE) Programs, by William R. Morton
and Kirsten J. Colello.
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one 529 plan into another can count the years the assets spent in the first account toward the 15-year limitation,
as well as the treatment of repaid early withdrawals when meeting the past five years limitation.22
Income Tax Treatment
Contributors to 529 plans receive no federal income tax benefit from funding a 529 plan. Instead,
the main beneficiaries (in terms of reduced income taxes) of 529 plans are the recipients of 529
distributions, who may be able to exclude the entire 529 withdrawal from income taxation. In
most cases, the recipient of the 529 distribution (and hence the person who may be liable to pay
tax on the distribution) is either the designated beneficiary or the account owner.23
Contributions
Contributions made to 529 plans are not deductible from income, meaning that contributions to
these plans are made using after-tax dollars. Additionally, this implies that contributors to 529
plans receive no federal tax benefit from contributing to a 529 plan. In contrast, many states allow
residents to deduct part or all of their 529 contributions from their state income taxes if they
contribute to an in-state plan. All 529 plan contributions are allowed to grow tax-free in the 529
account. Hence, unlike the typical bank savings account, where interest income is annually
subject to income taxes, the increase in asset values in a 529 plan account is not subject to current
income taxes while the funds are in the account.
Distributions
Distributions from 529 plans are not subject to federal income taxes if, for a given year, the
withdrawal entirely covers AQEE. In other words, if the amount of the distribution is less than or
equal to the AQEE, the entire distribution is tax free. In addition to this limitation, only a
maximum of $10,000 per beneficiary per year may be used for K-12 tuition expenses. Hence, if a
child’s K-12 education expenses were $7,000, but their parents withdrew $10,000 from her 529
account, a portion of the excess ($3,000) would be subject to taxation. A portion of any amount
that is in excess of $10,000 will be taxable.
When a distribution is used to pay for nonqualified expenses, the earnings portion of the
withdrawal is subject to the income tax and may be subject to a 10% penalty tax. In other words,
if the amount of a 529 withdrawal is greater than the beneficiary’s AQEE, then some of the
earnings portion of the distribution is taxable. The earnings portion of a distribution reflects the
growth of the value of the 529 plan and not amounts originally contributed (which are referred to
as basis). The percentage of the earnings portion subject to taxation is equal to the ratio of the
difference of the total distribution amount and AQEE to the total distribution amount. To
ultimately calculate the amount of tax the taxpayer will owe, the taxpayer’s marginal tax rate
must be applied to this taxable income. In addition, in many cases, a 10% penalty tax will also be
applied to this taxable income.24

22 For example, see Chris Stack, “Tax-Free 529 to Roth IRA Transfers are Here, But Questions Remain,” Saving for
College, January 18, 2024.
23 In the case of a prepaid 529 plan, the payment goes directly to the institution, instead of the beneficiary or the
account owner.
24 The 10% penalty tax is waived in the following cases: (1) the distribution is paid to the beneficiary after their death;
(2) the distribution is made because the beneficiary is disabled (the beneficiary is considered disabled if he shows proof
(continued...)
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Calculating the Taxable Portion of a 529 Distribution: A Stylized Example
Mr. Smith establishes an account in a 529 plan for his daughter Sara. He is the account owner and
his daughter is the designated beneficiary. He makes a one-time contribution (i.e., basis) of
$10,000. Five years later the account balance is $15,000 (i.e., it has increased in value by $5,000)
and Mr. Smith takes a $9,000 distribution for his daughter’s $9,000 tuition payment. But Sara
also receives a $4,000 tax-free scholarship. Hence, Sara has $5,000 in AQEE ($9,000 of tuition
minus $4,000 in tax-free aid). Notably, Mr. Smith pays Sara’s tuition costs and also designates
himself as the recipient of the 529 distribution, implying he (and not his daughter) will be liable
to pay any taxes on the 529 distribution.25
The steps to calculate the taxable portion of the distribution—and it is taxable because adjusted
qualified education expenses ($5,000) are less than the 529 distribution ($9,000)—are outlined in
Figure 1.
First, Mr. Smith must calculate the proportion of the distribution that is earnings. Since one-third
of the account balance ($5,000) reflects earnings (two-thirds of the account balance reflects
$10,000 of contributions), one-third of the distribution is attributable to earnings. Second, Mr.
Smith applies the earnings ratio (in this case, one-third) to the distribution. Hence, of the $9,000
distribution, one-third or $3,000 reflects earnings. Finally, Mr. Smith calculates the proportion of
the $3,000 earnings portion that is subject to taxation. The percentage of the earnings portion that
is subject to taxation is equal to the ratio of the difference of the total distribution amount
($9,000) and AQEE ($5,000) to the total distribution amount ($9,000). Ultimately, as Figure 1
illustrates, of the $9,000 distribution, $1,333 of it is includible in Mr. Smith’s income and thus
subject to taxation on his income tax return.

that the he cannot do any substantial gainful activity because of a disability. A physician must determine that the
disability is either life threatening or will have an indefinite duration); (3) the distribution is greater than qualified
education expenses (and hence the earning portion is taxable) because the beneficiary received tax-free educational
assistance as long as distribution is not more than the tax-free assistance; (4) the distribution was made as a result of the
beneficiary’s attendance at a U.S. military academy to the extent that the distribution is not greater than the cost of
attendance at such an academy; (5) the distribution was taxable as a result of reducing qualified expenses in order to
claim higher education tax credits.
25 The account owner of a 529 account selects the recipient of the distribution when filing out the program’s withdrawal
request form.
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Tax-Preferred College Savings Plans: An Introduction to 529 Plans

Figure 1. Calculating the Taxable Portion of a 529 Distribution: A Stylized Example

Sources: Congressional Research Service using information obtained from the Internal Revenue Service,
Publication 970: Tax Benefits for Education, http://www.irs.gov/pub/irs-pdf/p970.pdf; and Joseph F. Hurley, The
Best Way to Save for College: A Complete Guide to 529 Plans 2011-2012 (Pittsford, NY: JFH Innovative LLC, 2011).
Interaction with Other Education Tax Benefits
In addition to 529 plans, there are a variety of other tax benefits taxpayers (either the beneficiary
or the account owner) may use to lower their income tax bill based on education expenses.
Notably, taxpayers may be eligible to claim either the American Opportunity Tax Credit
(AOTC)26 or the Lifetime Learning Credit. A taxpayer cannot claim more than one of these tax
benefits for the same student in a given year.
To determine if any of their 529 distribution is taxable, a taxpayer must reduce their 529 qualified
education expenses by any amounts used to claim either the AOTC or the Lifetime Learning
Credit. The qualified education expenses as defined for 529 plans are not identical to the qualified
higher education expenses of education tax credits. However, since some expenses do overlap
(such as tuition and fees at higher education institutions, course-related books, supplies, and

26 For more information on the AOTC, see CRS Report R42561, The American Opportunity Tax Credit: Overview,
Analysis, and Policy Options, by Margot L. Crandall-Hollick.
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equipment), some taxpayers may (mistakenly) try to claim both an education tax credit and a tax-
free 529 distribution for such expenses.
For example, if an eligible taxpayer has $10,000 of tuition payments of which they used $4,000 to
qualify for an AOTC, the amount of qualified higher education expenses used to determine if
their 529 distribution is tax free is $6,000. Thus, if a 529 distribution is less than or equal to
$6,000, none of the distribution is subject to taxation because the distribution covered all of their
AQEE.
Rollovers and Transfers
To Another 529 Plan
Any distribution from a 529 plan for a given beneficiary which is rolled over into a different 529
plan for either the same beneficiary27 or a member of the beneficiary’s family28 is not taxable. A
distribution is considered “rolled over” if it is paid to another 529 plan within 60 days of the
distribution. A rollover between 529 plans for the same beneficiary is limited to once every 12
months. In addition, if the designated beneficiary of an account is changed to a member of the
beneficiary’s family, the transfer of funds is not taxable.
To an ABLE Account
Additionally, account holders can roll 529 plan assets into an ABLE account held by the same
beneficiary as the 529 plan. ABLE accounts are tax-advantaged savings accounts for individuals
with disabilities. States create qualified ABLE programs, and the federal government recognizes
them for tax purposes. Contributions are not eligible for a tax deduction, but qualified
withdrawals are excluded from the beneficiary’s income subject to tax. To open an ABLE
account, the beneficiary must have a qualifying impairment that began before age 26 (this limit
will rise to 46 in 2026 under current law). In addition to the tax benefit, these accounts benefit
holders because the federal government excludes some or all of the assets in ABLE accounts from
asset tests used for some means-tested federal benefits, such as Supplemental Security Income.
Rollovers from 529 plans are subject to the annual contribution limit to ABLE accounts ($18,000
in 2024) and to any state limits on aggregate 529 plan contributions.
To a Roth IRA
Federal law also permits qualified rollovers from 529 plans to Roth IRAs. Roth IRAs are
retirement accounts in which individuals contribute using after-tax income, but qualified
withdrawals are tax-free.29 Qualified withdrawals from Roth IRA plans include any made after
the taxpayer turns age 59½. Nonqualified withdrawals are subject to tax and a 10% penalty,
although this penalty is waived under certain circumstances, such as if used for higher education

27 Only one rollover from one 529 plan to a different 529 plan for the same beneficiary is allowed in a 12-month period.
28 For the purposes of a 529 plan, the beneficiary’s family includes the following: the beneficiary’s son, daughter,
stepchild, foster child, adopted child (or decedent of any of these children); brother, sister, stepbrother, stepsister;
father, mother, or their ancestors; son or daughter of a brother or sister; brother or sister of father or mother; son-in-law,
daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law; the spouse of any of the individuals
previously listed (including the beneficiary’s spouse); and first cousin.
29 For more about Roth IRAs, see CRS Report RL34397, Traditional and Roth Individual Retirement Accounts (IRAs):
A Primer, by Elizabeth A. Myers.
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Tax-Preferred College Savings Plans: An Introduction to 529 Plans

expenses; health insurance premiums for uninsured beneficiaries; or to build, buy, or rebuild a
first home (subject to a $10,000 limit).
Qualified 529 plan rollovers cannot exceed 529 plan contributions in the beneficiary’s name in
the preceding 5 years, in addition to any earnings on those same contributions. The 529 plan must
have been in the beneficiary’s name for the preceding 15 years. Rollovers for a designated
beneficiary are subject to a lifetime limit of $35,000. Additionally, the rollovers may not exceed
the annual contribution limit to IRAs ($7,000 for individuals under age 50 in 2024), minus the
aggregate contributions made to all individual retirement plans in that year.
These limitations present ambiguities that the IRS and Congress have yet to clarify. For example,
it is unclear whether a beneficiary could roll over assets held in an account that is eight years old,
but includes assets rolled over from another 529 plan held in the beneficiary’s name for eight
years prior.30
Gift Tax
A contribution to a 529 plan is generally not subject to the gift tax if the amount contributed is
less than the annual gift tax exclusion.31 For 2024, the annual gift tax exclusion is $18,000.32 For
example, a grandparent could contribute $18,000 to each of their seven grandchildren’s 529
accounts without being subject to the gift tax.33 In addition, a contributor may be able to deposit
more than the annual exclusion amount into a 529 plan without being subject to the gift tax.34 The
IRC allows a donor to make a contribution larger than the annual gift tax exclusion by treating the
contribution as if it were made ratably over five years. In other words, a contributor could have
opened a 529 savings plan for a beneficiary in 2024 and contributed up to $90,000 (five times
$18,000) without being subject to the gift tax. The contributor could not make another excludable
gift to that beneficiary’s 529 plan until 2029. In addition to these gift tax rules, for the purposes of
the estate tax, a donor can exclude the value of the 529 plan from their gross estate, even though
they maintain control of the account.
Interaction of Assets and Distributions from 529
Plans with Federal Student Aid
In addition to the tax advantages of 529 plans, these plans are also treated more favorably than
other types of college savings or investments when determining a student’s eligibility for federal
need-based student aid. For instance, 529 plans generally have a minimal impact on a student’s
federal expected family contribution (EFC). The EFC is the amount that, according to the federal
need analysis methodology, can be contributed by a student and the student’s family toward the
student’s cost of education. All else being equal, the higher a student’s EFC, the lower the amount
of federal student need-based aid he or she will receive. A variety of financial resources are

30 Chris Stack, “Tax-Free 529 to Roth IRA Transfers are Here, But Questions Remain,” Saving for College, January 18,
2024.
31 Contributions to 529 plans treated as a completed gift which implies the transfer of ownership from the contributor to
the beneficiary, even though contributors to 529 plans maintain control of the accounts.
32 $36,000 for a married couple using gift-splitting.
33 Each grandparent could contribute $18,000, meaning they could deposit $36,000 per grandchild as a couple without
being subject to the gift tax.
34 For an overview of the current law of the gift tax, see CRS Report R42959, Recent Changes in the Estate and Gift
Tax Provisions, by Jane G. Gravelle.
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Tax-Preferred College Savings Plans: An Introduction to 529 Plans

reported by students and their families on the Free Application for Federal Student Aid (FAFSA).
These resources are assessed at differing rates under the federal need analysis methodology.35
Distributions from 529 plans are generally not considered income in the federal need analysis
calculation and are therefore not reported on the FAFSA.36 However, the value of the 529 plan
may be considered an asset in the federal need analysis methodology.37 When calculating a
student’s EFC, the federal need analysis methodology considers a percentage of the student’s
assets and a percentage of the parents’ assets (above an “asset protection allowance”) reported on
the FAFSA.
This rate is typically lower for parents of students who are classified as dependent students for
FAFSA purposes (which differs from the classification of dependent for tax purposes)38 than it is
for the dependent students themselves (who also receive no asset protection allowance). 529 plans
with a dependent student as beneficiary are considered an asset of the parent, as long as the
custodial ownership of the plan belongs to either the parent or the student. Dependent students
can therefore benefit from a lower EFC and the potential for more federal need-based student aid
than they might receive if the asset was considered their own. For students who are classified as
independent students for FAFSA purposes, 529 plans are treated as an asset of the student, as long
as the custodial ownership of the plan belongs either to the student or student’s spouse (if
applicable).39
529 plans that are owned by someone other than the student, parent, or spouse are not reported as
an asset on the FAFSA. Distributions from these 529 plans were previously reported as untaxed
income for the beneficiary on the FAFSA, meaning they were assessed at a higher rate than assets
in federal need analysis methodology. However, under the FAFSA Simplification Act (passed as
Division FF of P.L. 116-260), such 529 plans do not need to be reported on the FAFSA. This
change was scheduled to take effect in the 2023-2024 aid year, but Congress delayed it to the
2024-2025 aid year in the FAFSA Simplification Act Technical Corrections Act (passed as
Division R of P.L. 117-103).

35 The details of the federal need analysis methodology are beyond the scope of this report. For more on the topic, see
CRS Report R44503, Federal Student Aid: Need Analysis Formulas and Expected Family Contribution, by Benjamin
Collins and CRS Report R46909, The FAFSA Simplification Act, by Benjamin Collins and Cassandria Dortch.
36 Additionally, distributions from 529 plans are not considered a resource when calculating other estimated financial
assistance (EFA) during the federal aid packaging process. For more information on EFA and the packaging of aid, see
the 2024-2025 Federal Student Aid Handbook at https://fsapartners.ed.gov/knowledge-center/fsa-handbook/2024-2025.
37 For prepaid 529 plans, the asset value is the refund value of the plan.
38 For the purposes of taxes, IRC §152 defines dependents. The definition includes (but is not limited to) a requirement
that the dependent has the same principal residence as the taxpayer for more than half the year, and that the dependent
has not provided over one-half of their support. In contrast, a student aged under 24 is generally considered a dependent
for financial aid purposes. If certain criteria are met, the student is considered an independent student for financial aid
purposes. A student can determine their dependency status for financial aid at http://www.finaid.org/calculators/
dependency.phtml.
39 The treatment of assets held by independent students differs by whether the student has dependents of their own
(besides a spouse) for the purposes of FAFSA. Generally, for students with assets above the asset protection allowance,
increasing the assets of those with such dependents causes their EFCs to rise by less than a similar increase in assets
would for students who do not have such dependents. See Tables 2, 3, and 4 of CRS Report R44503, Federal Student
Aid: Need Analysis Formulas and Expected Family Contribution, by Benjamin Collins.
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Author Information

Brendan McDermott

Analyst in Public Finance

Acknowledgments
Margot Crandall-Hollick wrote a prior version of this report.

Disclaimer
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under the direction of Congress. Information in a CRS Report should not be relied upon for purposes other
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Congressional Research Service
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