Strategically using a 529

Some states have tax credits for 529 contributions. I think there has been significant discussion on how 529 accounts aren’t really worth it for much more than that.

A common strategy is to just “rinse” your funds through the 529. The meaning is to just deposit it for the short-term, not to invest. The point is to just get the tax credit. This is a great option for some because otherwise there would be zero tax advantage for college spending (kind of the boat that I am in right now…).

I was looking at what qualifies which is not a problem for me because our annual tuition spend it about $9k (good in-state tuition at a good state university), and since we’re splitting cost (2/3 parents, 1/3 student), we are still slightly over our maximum deposits for the tax credit anyhow ($1k credit for $5k in deposit, or 20%). However, housing costs and many other items are also included.

This got me to thinking (because I am essentially a perpetual student… 180 undergrad credit hours and 60 graduate credit hours… and likely more to follow), this could be a way to lower my tax burden later when it is just me and the wife. Work offers tuition reimbursement, so that covers the costs of attending classes, but then I could potentially use the 529 to pass some other funds through. There are some rules, like it has to be equivalent to stating on-campus. But I don’t know much beyond that.

Have others developed any strategies?


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There are complex strategies for those willing to plan ahead if a state has generous incentives.

For Minnesota I noticed there was a generous state match. I remember suggesting to a single friend that she should open an account now for herself, and get the state match. It could be transferred to a child later. She rejected the idea on the basis she was still looking for a boyfriend, and financing her child’s (should she have one) college education seemed low priority. Statistically, women in her circumstances are very likely to marry, get pregnant, and wish to send their child to college, and the rate of return on such an investment would have been good.

I suspect most state have closed the loophole of taking a benefit for a contribution, and then not having a offset if the funds were taken out later and not used for qualified educational expenses. However, there may be cases where you plan to move out of the state and might benefit from this.

Some state give a benefit regardless of how long the funds stay. If you have a child in college, it may pay to deposit funds into a 529 plan, get the tax benefit, and then take it out to pay tuition within a month or so.

The Federal rules permit transfer within a family (defined to include cousins). This can make it possible to open many 529 plans if enough relatives live within a state and then collect incentives. For instance Md. permits a subtraction from income for amounts put into a plan for a state resident (limited to $2500 per year per relative, with a carry forward). This is generous enough so someone with numerous relatives in the state can easily eliminate all Md. taxes. It appears that reducing the Md. taxable income to a negative number is not beneficial.

The above problem can be avoided by using an out of state plan, and then bringing money into the Md. plan when the tax break would be useful.

One trap; to watch out for is that the Feds do not allow double dipping. The Opportunity credit can bring you up to $2500 per year per student. However, if all tuition is paid from a 529 plans, this cannot be used. This can be a problem if one has a prepaid tuition plan which pays all the tuition, because then you will have no tuition payments to get the credit for.

In Md. the prepaid tuition plans have a value that can be converted to cash for a regular 529 plan. By doing this I benefited (the cash value due to an up stock market was actually higher than the tuition). Then by paying all of the tuition except for $4,000 from the plan, I could get the $2500 credit (in 2017).

On hidden trap with 529 plans is that it makes it hard to refuse a child that wants to go to an expensive school. It is not clear that the much high tuition and expenses for most private college are worth the much higher expenses (compared to a good state school or even a community college). It is hard to say we cannot afford the private university when you obviously have enough money set aside (and could use it for another child, or a grandchild, or medical school etc.). Because of the tax penalties, yoiu may not wish to take money out other than for education, even if it could be useful for retirement or charitable donations.

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I think this is only an issue that needs to be resolved between parents and children rather than a gotcha of 529 Plans. For us, each of our kids has a separate 529 Plan (because of state deductions being per child covered by a 529). And we’ll basically provide a set amount of money for college. An amount that’s enough money to pay fully for a good public college/university + room & board. Basically for good free college education at a reasonable cost university. Whichever college, the child goes to, she’ll get the same amount of money. You go to expensive private university, fine. Get merit scholarships and/or get loans. On the flip side, if she gets scholarships, she gets a freebie of the remaining money in the 529 plan. That’s an incentive to work on test scores and make a value decision on her college education. Not saying it’s the only way to avoid this 529 plan “trap” but it’s a way to control your college education costs.


The biggest “hidden” trap of the 529 is that it gets counted as an available asset for financial aid models. Open a Roth IRA for your kid instead–all they need is earned income. Distributions for education are not subject to the early penalties and the assets are not counted for financial aid calculations.


I’m guessing “hidden” is in quotes because the first advice is to not have the parents own the account :slight_smile:

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You don’t want the student to own the account either. Grandparents are ideal.

Even then, the 529 distributions will be counted. So, one technique I’ve seen is that you should wait to do the 529 distributions until halfway through junior year (once Senior year financial aid has already been calculated). Then you take all the 529 distributions you can.

I put “hidden” in quotes just because all of this stuff is out there for a sleuth, but the pitfalls are glazed over. Instead, you just have CPAs hawking it as “another way to save some tax money.”


For most kids, earned income requirement is a pretty significant barrier to entry until they are 15+.

But I agree that grandparents are ideal for 529 plans since that takes it off the FAFSA calculations. But only until they start paying for bills which is exactly what you described. You have to wait until senior year FA is decided, then you can pay from grandparents accounts. Or if parents have a 529 plan of their own, you could rollover some money from grandparents 529 plans right after the FAFSA is filed for a given year. (be careful of recapture rules for those rollovers though)

Parents are the next best thing since 529 plan assets reduce FA by only 5.64%, not 20% in case the student owns the 529 plan themselves. That’s for FAFSA though but many private colleges use the college board CSS profile instead which counts all 529 plans as assets so it may not matter much who owns the 529 plans.

And beyond assets, a lot more emphasis is placed on parents earnings. If the parents are earning 6 figures (even low enough to qualify for Am. Opportunity tax credit), student is not gonna qualify for much need-based scholarship regardless of assets. Expected family contribution (EFC) is gonna be higher than what most colleges costs anyway. In our case, EFC is about $79k with the 529 plans we own, and would be $67k if owned by other relatives. Either means $0 need-based scholarship at many institutions. So if that’s your situation, the 529 plan is basically only a tax savings tool (no tax on earnings and possibly state tax advantages).

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There are some barriers involved, but creating an LLC for this sole purpose is probably a good idea in the long run.

It is useful to do the Roth IRA if you intend to accumulate money. I don’t accumulate much at all, I just “rinse” the funds through the 529 to get the tax credit at the time of tuition payment (a month in advance).


Does that take care of the FAFSA issue as well? It’s not available in your 529 at the time you fill out the financial aid info. You then deposit it there and pull it back out (tax credit having been pocketed) before it can affect FAFSA.

IIRC, scholarships are always merit-based, while grants are need-based.

Does this mean that in this scenario the 529 is only used for the final 1.5 years worth of expenses?

It should work for 529 accounts owned by parents since withdrawals from 529 plans owned by student or parents are not recorded by FAFSA (which is why the rollover from other relatives’ accounts works). The money is in Roth IRA so shielded from FAFSA, then in 529 Plan, then withdrawn from 529 Plan to pay for college expenses.

Yes, strictly speaking, the withdrawals from relatives’ 529 Plans would only occur after the final FAFSA application so in the final 1.5 yrs. But the rollover from the relative’s account to a parent account is one way although they need to be within the same state to avoid some recapture.

If you’re financing some of the college costs through regular cashflow in addition to 529 plans, you may be able to use federal subsidized Stafford or Perkins loans (which do not accrue interest while in school).

Let’s say college expenses amount to $40k/yr for 4 years ($160k total) and you are planning to pay those expenses with 4x$20k = $80k from 529 Plans from relatives and 4x$20k = $80k from regular annual cashflow. In year 1 and 2, take out 2x$20k subsidized Stafford loans. Pay the rest (2x$20k) from cashflow. Then after the last FAFSA is done, pay all college expenses (2x$40k) from the relatives’ 529 Plan, and use cashflow (2x$20k) to pay off the federal student loans. That way you never pay interest on the loans and you defer FAFSA noticing payment being made from relatives’ 529 Plan.

The thing to be wary of is not to pay off the loans from the 529 Plan as student loans are not - under current law - qualified education expenses (no clue why not but maybe to plug loopholes).

Could you expand (expound?) on this? Is all of the planning moot if the child’s parents are earning above a certain threshold?

My point is the FAFSA application takes into account a lot of the parents income and will determine an Expected Family Contribution (EFC or the amount that FAFSA estimates you can pay per year) that is so high that who owns what assets is in practice insignificant.

Say your household MAGI is $160k (still fully eligible for Am. Opportunity tax credit), you’re maxxing out 401k/403b annually, and you have $100k in 529 Plan. You’re EFC calculated during the FAFSA application could end up being say $75k.

If you carefully plan your $100k 529 Plan to be excluded from FAFSA calculations (say it’s owned by grandparents), it will save you a reduction in EFC of 5.64% of the 529 Plan balance or $5.6k. Your EFC is still gonna be about $70k. Thus, if your kid plans on attending a college for which total expenses run less than $70k/yr, the difference of $5.6k in EFC is immaterial to you since FAFSA still considers that you should be able to cover it all without need-based financial aid.

So I’d recommend people use online estimator for their EFCs ahead of doing all this planning. (with the important caveat that laws do change: 529 plans used to be excluded from FAFSA a while back for example)

For comparison, according to college board data, average tuition + fees is $35k at private colleges, $10k at public in-state ones, $25k for public out of state. Room and board is $10-12k. Books about $1.25k. So even average private institution, you’re looking at just under $50k/yr total.


Thanks, I have no understanding of the financial aid system.

If you don’t have money, you get aid. If you have lot’s of money you don’t. In between, it takes a ton of planning to get any aid. A bit part of that planning is who gets attributed the value of the of your assets. Someone owns the 529 and someone is the beneficiary (there are rules about the relationships required: dependent and/or familial). A grandparent can own it, which means it is his/her/their asset, but the beneficiary can be the grandchild. In the finaid calculations, it is the parent/guardian asset that are calculated and not the grandparents. So, it is an easy way to bump the numbers down if you have 529 assets.

Right, I get that. But who owns assets can be “adjusted.” Who earns income can’t (for the most part). So if parents’ earnings factors in, then it sounds like, if earnings are high enough, there’s no benefit to adjusting asset ownership for financial aid purposes.

That’s only FAFSA though. For CSS Profile, you have to disclose ALL 529 accounts for which you are named as one of the beneficiaries. So grandparents need to hold someone else as beneficiary until time the money will be used for the student.

And for either, the gig is up once you start paying tuition from the grandparent 529 Plan (although the rollover method should still work to avoid paying directly). But it’s not as easy as it sounds (or as easy as it used to be).

Honestly, the best method to get need-based aid is probably getting your student married because the emancipated student is then no longer linked to parental assets at all. I’ve been working on trying to convince DD to go along with the plan but unfortunately without any luck so far. Somebody come up with a finaid matchmaking service for fun & profit. Could work like finding a roommate or just about. :wink: