Physician Finances

Choosing A 529 Plan

At the time of writing this post, there are still 3 days to contribute to a 529 plan to take advantage of tax savings this year. So, if you haven’t maximized your annual contribution, now is the time to do so. For most families, life’s five biggest expenses are food, housing, healthcare, taxes, and children’s college education. The 529 plans uniquely allow you to lower your overall costs of two of these: your children’s education and your taxes. I funded all 4 of my children’s college costs through 529 plans and now I am looking at 529 plans for a grandchild.

What is a 529 plan? College is expensive. The average 4-year public college currently costs $102,640 and the average private college costs $215,796. Given the projected annual inflation in college costs, 18 year from now, a public university will cost $265,700 and a private college will cost $559,604. Financial aid and scholarships reduce these costs for most families but physicians generally have a high enough income that exempts them from financial aid and most scholarships. A 529 plan allows a parent (or grandparent or just about anyone) to put money into a 529 investment where it grows tax-free and when distributions are taken out for educational expenses, there is no tax on those distributions. These tax advantages make the 529 plans the absolutely best way to save money for a child’s college education. The account owner is usually a parent or grandparent; the account beneficiary is the child. If the account owner has several children/grandchildren in the 529 accounts that he/she owns, then residual funds in the account of one child can be rolled over into the account of another beneficiary after the first child completes their education. In addition to using 529 plans to pay for college, the money in a 529 plan can also be used to pay for K-12 tuition of up to $10,000 per year – this can be useful for children attending private elementary and secondary schools.

Each state has its own 529 plan. The 529 plans are state-specific and no two states’ plans are exactly alike. Most states will offer a variety of specific mutual funds within the 529 plan that you can choose from. Some states allow you to deduct contributions from your state income tax. Some states provide modest matching contributions. The annual expenses charged to the 529 account vary from state to state. The good news is that you do not need to live in a state to open a 529 plan in that state but the bad news is that tax deductions and matching contributions usually only apply when contributing to a 529 plan when you are a resident of that particular state. In general, the money in the 529 plans can be used for a college anywhere in the country and not just colleges located in the state administering the 529 plan.

Savings plans versus pre-paid tuition plans. Most 529 plans are savings plans that are essentially investment accounts that allow withdrawals for any education-related expenses (tuition, books, and room & board) for any college anywhere in the country. Five states currently also offer pre-paid tuition plans that allow the 529 contributions to purchase tuition for colleges in that state (Florida, Maryland, Michigan, Mississippi, and Nevada). This essentially allows you to lock in tuition purchases at today’s tuition prices and given how rapidly tuition costs have risen each year, there can be an attraction to the pre-paid tuition plans. I personally do not like the pre-paid tuition plans and even when Ohio did have a pre-paid tuition plan in the past, I avoided it. The reason is that if the child elects to go to a college in another state, the tuition credits cannot be used for out-of-state colleges. So, unless you live in one of the five states with pre-paid tuition plans AND your are 100% certain that your child will go to a public college in that state AND you are 100% certain that your child will not get a scholarship to attend that college, it is best to use a 529 savings plan rather than a 529 pre-paid tuition plan.

How to choose a 529 plan

Know whether your 529 plan contributions are tax-deductible. If the state that you live in offers a tax deduction (or a tax credit) from state income tax on contributions, then your state’s 529 plan is the one you should go with. Seven states even allow residents to deduct contributions made to 529 plans in other states (Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana, and Pennsylvania). However, some states do not have state income tax and consequently there is no tax deduction advantage to residents of these states: Alaska, Florida, New Hampshire, Nevada, South Dakota Tennessee, Texas, Washington and Wyoming. Other states do have state income taxes but do not allow you to deduct 529 contributions: California, Delaware, Hawaii, Kentucky, Maine, New Jersey and North Carolina. For the rest of the states, the annual amount that is tax deductible varies from $500 ($1,000 if filing jointly) in Rhode Island to $20,000 ($30,000 if filing jointly) in Colorado. Here in Ohio, the amount that is tax deductible is $4,000 (regardless of whether filing single or jointly) but if you contribute to 529 accounts for multiple children, you can deduct contributions of up to $4,000 for each child from your Ohio state income taxes each year. If you live in a  state where there is no tax deduction, then you should base your 529 choice on the mutual fund options and annual expenses – this may mean investing in a 529 plan from a different state than the state that you live in.

Know what the fees are. There are many different fees that can be associated with each state’s 529 plan. In many cases, the amount of fees charged by the plan may be the deciding factor in selecting one state’s 529 plan over another state’s. Fees can include program management, maintenance, and administrative fees charged by the 529 plan itself. In addition, there will be investment fees charged by the mutual funds within the 529 plan. Many states offer “advisor-sold plans” where there is a company that actively manages the investment selections and charges additional advisor fees. All of these various fees can add up and can erode the value of the account if the fees are excessively high. The good news is that with different 529 plans in all 50 states plus the District of Columbia, competition between the states has helped to keep 529 fees down.

Know what the investment options are. Each 529 plan has multiple different mutual funds that you can select. These may include various stock funds, bond funds, age-based funds, advisor-directed accounts, certificates of deposit, and savings accounts. As a general rule, the younger a child is, the more aggressive option you should choose. As an example, a stock market index fund would be best for a 1-year old and a bond fund or certificate of deposit is preferable for a 17-year old. In 529 plans, I like the age-based funds because you can put money in the fund and then the investment company will automatically adjust the ratio of stocks:bonds each year based on the child’s age. Because of the lower expenses, I also prefer index funds over more costly advisor-directed funds.

Is there a match to contributions? In a few states, there is a small match to initial contributions for residents of that state. These can be an initial incentive to open new accounts. For example, Rhode Island will contribute $100 to 529 plans opened by Rhode Island residents for children before their first birthday. Illinois has a $50 contribution to new 529 plans for Illinois residents. In other states, a portion of initial contributions will be matched for low or middle income families. For example, California will match initial contributions up to $200 for California residents making less than $75,000 per year.

Where to get information. Start by checking with your state’s 529 plan website to learn whether contributions are tax-deductible, what the fees are, and what the investment options are. If you are in a state that does not allow you to deduct contributions from state income taxes, then you should compare different states’ 529 plans and chose one based on other factors, such as annual fees and mutual fund options. There are several good websites that allow you to compare 529 plans from different states, for example, and The 529 plans are constantly changing, so a plan that may be best for you one year may not be the best the next year. Forbes, Investopedia, and Morningstar rate 529 plans each year and these websites can provide useful recommendations.

What about grandparents?

For the past 3 decades, I based my 529  strategy based on the needs of my own children. Now that I am a grandfather, there are a number of other factors to consider when contributing to a 529 plan for a grandchild.

  • A child can be the beneficiary of more than one 529 account. Most typically this will happen if a parent has a 529 plan and one or both sets of grandparents want to open their own 529 account for the child. Or, the parents are divorced and both want to have separate 529 plans for their child.
  • If the 529 plan is in a state that considers contributions as tax-deductible, the grandparent can deduct contributions regardless of whether the 529 plan is owned by grandparent or owned by the parent (as long as the grandparent is a resident of that state).
  • Since the state tax deduction usually only applies when a grandparent contributes to his/her state of residency’s 529 plan, it is best to open a second 529 plan if the child’s parents live in another state and have their own 529 plan in that state.
  • A 529 account from one state can be transferred to a new 529 plan in a different state once per year. This can be an advantage if the 529 owner (parent or grandparent) moves from one state to another and wants to take advantage of state income tax deductions in the new state. It can also be an advantage if a different state’s 529 plan becomes more attractive due to lower expenses or better investment options.
  • The amount of money in a 529 plan that a parent owns will affect a child’s eligibility for financial aid in the FAFSA application. However, the money in a 529 plan that a grandparent owns is not factored into financial aid calculations for FAFSA purposes until that money is withdrawn for the child’s education (at which time, it will be considered as part of the child’s non-taxable income on the FAFSA form). Therefore, the best strategy is to use the parent’s 529 account for the first two years of college (when financial aid applications from FAFSA will be submitted) and then use the grandparent’s 529 account for the child’s last two years (when the FAFSA forms have already been submitted). This strategy optimizes the child’s financial aid and scholarship eligibility.
  • In most states, the ownership of a 529 plan can be transferred (for example, from a grandparent to a parent when the child gets close to college age).
  • Contributions to 529 plans are considered as a gift for federal income tax purposes. Therefore, they are subject to the maximum of $15,000 per person that can be gifted to an individual per year without that person having to pay income tax on the gift. If the grandparents (or parents) are married and file jointly, then each grandparent (or parent) can gift $15,000 for a total of $30,000 from the 2 grandparents (or the 2 parents). A unique feature of 529 funding is that the IRS allows people to do a 5-year front load to the 529 fund without incurring gift taxes. So, a grandparent or parent can contribute $75,000 initially to the 529 plan and then not do any contributions for next 4 years. This can allow more money to grow tax-free with the result of a larger balance in the account when the child reaches college age.
  • In addition to funding a 529 plan, grandparents can also pay tuition directly to the college once the grandchild is enrolled. A provision in the tax code exempts these direct tuition payments from the $15,000 per person per year gift limit ($30,000 if married and filing jointly). This is a strategy that parents often use to help pay for a child’s college expenses without exceeding the annual gift amount limit but it also applies to grandparents. For example, tuition at the University of Notre Dame (one of my children’s alma mater) is currently $58,843 per year. If a grandparent writes a check to a grandchild for that much money, the grandchild would have to pay income taxes for everything over $15,000 (in this case, that would be $43,843 of taxable income). On the other hand, if the grandparent pays the University of Notre Dame the $58,843 directly, then none of it appears as taxable income for the grandchild.

What I did

When 529 plans first came into existence, the Ohio plan was not very good – the mutual funds offered were expensive, the fund’s performance was poor, and the tax breaks were not attractive. So, I initially invested in Iowa’s 529 plan (at the time, I had never stepped foot in Iowa). The reason was that Iowa offered Vanguard index mutual funds with low expenses. When Ohio later changed to offer Vanguard funds and the tax deduction became more attractive, I moved my 529 fund from Iowa’s to Ohio’s. I selected age-based Vanguard index mutual funds for each of my four children and then did monthly direct deposits from my checking account into the Ohio 529 fund. By the time each child was in college, I had enough saved in their 529 accounts to pay for tuition, books, room & board for an in-state public university. When each of my children graduated from college, I rolled over the residual balance in their 529 account into one of my other children’s accounts. I am still using the residual fund balance in my youngest child’s 529 plan to help him out with his medical school costs.

For my new grandchild, I will open a new account in my Ohio 529 plan under my ownership to take advantage of the tax deduction on contributions to the plan. In the unlikely event that there is a residual balance in my son’s 529 account when he finishes medical school, I will roll that balance over to my grandchild’s account. If/when I have additional grandchildren, I will open new Ohio 529 accounts under my ownership for each of them so that if one of them gets a college scholarship or does not go to college, I can roll their fund balance over into one of the other grandchildren’s 529 accounts. I will likely hold off on taking distributions out of their 529 accounts until their junior and senior years of college in order to avoid negatively impacting their financial aid eligibility.

The time to act is now

This year, New Years Day falls on a Saturday so most state offices are closed on December 31st for a state holiday. Therefore, you have until December 30th to make contributions to a 529 plan this year in order to take advantage of a 2021 state tax deduction (if your state allows 529 contributions to be tax-deductible). Education is one of the best gifts that you can give to a child and 529 plans are the best way to invest in that education.

December 28, 2021

By James Allen, MD

I am a Professor Emeritus of Internal Medicine at the Ohio State University and former Medical Director of Ohio State University East Hospital