'One Big Beautiful Bill' expands 529 plans. But are there better options?
President Donald Trump's mega tax bill will expand the uses for 529 education savings plans, but enough limitations remain to potentially give some investors pause, some experts say.
The legislation dubbed the "One Big Beautiful Bill Act" by Trump, who signed the bill into law over the weekend, significantly increases the options for how 529 plans can be used, after they have been mostly limited to qualified higher education expenses and contributions up to $10,000 annually for K-12 tuition. Now, they will be able to be used for various costs, from standardized test fees to educational therapies and workforce training and credentials.
State-run, tax-advantaged 529s allow money to grow tax-free, and take tax-free withdrawals when used for qualified education expenses. Unused money can, under certain conditions, be rolled into a Roth IRA, transferred to a related beneficiary or used to repay student loans.
However, the limitations still in place may not always make 529s worthwhile for big savers, some experts say.
After contributing each year to his almost seven-year-old niece’s 529 education savings plan since she was a baby, Richard Pon’s having buyer’s remorse.
“Although the income in a 529 plan is tax deferred and tax-free if used for qualified education purposes, my niece would have been better off if I invested my gifts to her in a taxable account since (then) I am not limited by a small pool of investment choices,” said Pon, a certified public accountant in northern California.
Limited investment choices are only one negative of investing in 529 plans, he said. Others include different state rules, rigid restrictions that remain on how the money can be spent and the possibility you may not know when someone has opened a 529 for you.
How does the One Big Beautiful Bill Act affect 529s?
The OBBB will allow up to $20,000 annually tax-free withdrawals for K-12 curriculum, books, online resources, tutoring, educational therapies for students with disabilities. Dual enrollment fees for college courses and withdrawals for standardized testing fees, tuition and materials for certificate programs, trade schools, and other credentialing programs recognized under federal law will also be tax free.
That’s significantly more than higher-education costs, $10,000 annually for K-12 tuition only, a $10,000 lifetime limit on student loans and qualified expenses at a trade or vocational schools or registered apprenticeship programs.
In both situations, up to $35,000 in unused funds can be rolled into a Roth IRA under certain conditions or beneficiaries can be changed to another relative.
How do 529 plans grow savings?
After-tax money is added to a state 529 plan. The money can be put in one of various portfolios that hold a combination of mutual funds that may grow your money faster.
The money grows tax free, and qualified withdrawals are tax-free. Some states also offer tax deductions or credits for the amount you save.
However, most of the portfolios are limited to mutual funds and comprised of age-based target funds.
“Most 529 plans do not offer sector specific mutual funds such as the tech sector, and I don’t think any plans allow individual stock purchases,” Pon said.
Are 529s worthwhile?
The plans are a good way to save for education, if that’s not the only savings vehicle you’re using, said Lori Gross, financial and investment advisor at Outlook Financial Center in Troy, Ohio.
“We don’t discourage other family members like uncles to open a 529 for a child, or if you have a high school job and want to put some money aside for yourself, but don’t put big money in,” Gross said. One reason is that 529s are counted on the Free Application for Federal Student Aid (FAFSA) as an asset and will reduce student aid, she said.
Federal tax law doesn’t allow any tax deduction for 529 contributions, but some states do. They all differ though and can be confusing and require a lot of research to determine the best choice. Some states only allow a tax deduction or credit for residents while others cap annual or lifetime deductions. A tax credit reduces your taxes dollar for dollar, whereas a tax deduction lowers your taxable income.
“For many taxpayers, I bet the state tax incentives are why they are (contributing to a 529),” Pon said.
Still, some say the expansions under the OBBB make 529s attractive to a wider range of people.
"The 'One Big Beautiful Bill' has officially transformed the 529 from a college savings account into a K-Career-Retirement powerhouse," wrote Jamie Dunn, certified financial planner at Prudential Advisors, in a social media post, noting the benefits run from kindergarten to rolling unused funds into a Roth IRA.
Adding K-12 course materials, not just tuition, also benefits home school families, according to the nonprofit Independent Women’s Forum.
"The 529 expansions hold transformative potential, providing homeschool families with financial and educational flexibility," the organization said in a statement. The "bill could make educational dreams more attainable for homeschoolers, one tax-free withdrawal at a time."
What are drawbacks of 529 plans?
- Limited investment choices, which can dampen earnings growth.
According to Saving for College, the top-ranking Maryland College Investment Plan showed a 10-year average return of 7.04% as of March 31. That’s below the broad S&P 500 index average between 10% and 12%.
Pon compared $10,000 invested in a 529 plan with a 10% annual return versus a traditional brokerage account with a 15% return and no realized gains until year 18 in California, where there’s no 529 plan tax deduction or 529 plan tax credit.
Even after paying 15% federal long-term capital gains tax, 3.8% net investment income tax and 9.3% California tax, he said “I could have earned more than 10% a year and would be better off.” He estimated the brokerage account would have earned nearly $36,200 more than the tax-free 529 plan.
- Rigid rules. Though 529 plans are becoming more flexible, some rules are limiting, Pon said.
For example, beneficiaries can tap a 529 plan for non-college expenses like K-12 tuition, but the annual cap is $10,000 now and will be raised to $20,000 under OBBB per beneficiary, not per 529 plan. Additionally, not every state considers those qualified expenses and will tax those withdrawals.
There is also the $10,000 lifetime cap that can be used to repay student loans, Pon noted.
- 529 beneficiaries may not know they’re eligible. When Pon’s mother was sick, he opened her mail and was shocked to see she had started a 529 plan for his son he didn’t know about. Further, she had opened 529 plans for his three cousins and no funds were ever spent. Now, they’re all graduated. “I suspect there are tens of thousands of 529 plan accounts that people opened and forget about and never get used for college or other eligible expenses,” Pon said.
What are some alternatives to 529 plans?
- Traditional brokerage accounts have unlimited investment choices and can be used for tax loss harvesting to reduce tax burdens. Money usage is not limited. However, they also count as assets and can reduce financial aid packages.
- Cash value life insurance policies remain in the parent’s name and aren’t counted towards financial aid so more money can be contributed, Gross said. Plus, the money is invested, guarantees growth and can be used for anything, not just school. However, these can be complex, and premiums can be high depending on the structure.
- Roth IRAs aren’t counted as assets when calculating financial aid and contributions can be withdrawn tax free and used for anything, including education expenses. However, distributions are considered untaxed income that can be counted in calculating financial aid. Annual contributions are capped and there are income limits for contributions. Americans also need to make sure if they draw from Roth IRAs that they aren’t diminishing retirement funds for themselves.
No one savings plan is for everyone, and not every investor can beat a stock index or target date performance, Pon said. But "I would say for some experienced investors, it may be better not to have a 529 plan."
Medora Lee is a money, markets, and personal finance reporter at Paste BN. You can reach her at mjlee@usatoday.com and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday.