529 Plans: Smart or Not? What High-Income Families Need to Know

If you’re already thinking about your kids’ or grandkids’ education, a 529 plan probably came up early in the conversation. The tax-free growth, tax-free withdrawals for qualified expenses, and some estate planning perks all sound good on paper.

But for high-net-worth families, especially those with more than $1 million in assets and students heading to private universities, the benefits of a 529 aren’t always as clear-cut. In fact, there’s a little-known trap that could work against you when it’s time to apply for financial aid.

What’s the Appeal of a 529 Plan?

A 529 plan is a state-sponsored education savings account that allows your money to grow tax-deferred. As long as the funds are used for qualified education expenses such as tuition, books, and room and board, they can be withdrawn tax-free.

You can contribute large sums, even frontload five years’ worth of gifts, and retain control over the account. Plus, assets inside a 529 are considered outside your estate for tax purposes. It’s a popular tool for families who want to plan ahead and minimize taxes.

Where It Gets Tricky: The Financial Aid Trap

Here’s the part that doesn’t get talked about enough: Depending on how your 529 is owned and structured, it could reduce your child’s eligibility for financial aid.

529 plans owned by a parent are counted as a parental asset on the FAFSA (Free Application for Federal Student Aid), which means about 5.64% of the asset value is expected to be contributed each year. That’s manageable.

But if the 529 is owned by a grandparent or another relative, the picture changes. Once distributions are made, they are counted as student income on the FAFSA for the following year. Up to 50% of a student's income can be assessed in the aid formula. That’s the trap.

What Does This Mean for High-Income Families?

If your income or asset level already disqualifies you from most need-based aid, the trap may not seem like a big deal. But in some instances, especially when applying to private colleges that use CSS Profile or offer merit aid, it could still cost your family money.

That’s why how you structure your 529 matters. Ownership, timing of withdrawals, and coordination with your overall tax plan all affect the outcome.

Better Strategies to Consider

If you’re the parent, owning the 529 directly is often the simplest option for avoiding surprises. If you’re the grandparent, one strategy is to delay using the 529 plan until after the student’s junior year, so that any distributions don’t appear in the final FAFSA filing.

Another option is to use the 529 for graduate school instead of undergraduate studies or to utilize other non-529 assets for the early college years and save the 529 for later use. Each of these approaches reduces the impact on financial aid calculations.

Other Considerations: Flexibility and Control

529 plans are fairly rigid. If your child doesn’t attend college or doesn’t use all the funds, you can change the beneficiary, but you’ll pay income tax and a 10% penalty on earnings for non-qualified withdrawals.

With recent rule changes, 529 plans can now be rolled into a Roth IRA under certain conditions, but the rules are limited and the amounts are capped. It’s helpful, but not a catch-all solution.

How 529s Fit into the Bigger Picture

Rather than seeing a 529 as the go-to education tool, it’s more effective to see it as one tool in a broader strategy. Depending on your goals, tools like taxable brokerage accounts, irrevocable trusts, and insurance-based solutions can also support education funding, often with more control, flexibility, or tax efficiency.

The question isn’t just whether to use a 529. It’s how to use it and whether it supports or hinders your long-term family wealth goals.

Think Beyond Just Tuition

Education funding is one piece of a much larger financial puzzle. It’s about timing, ownership, and tax exposure, but also about ensuring that your strategy aligns with your values, your retirement needs, and your legacy.

If you want help reviewing how 529s or other education funding strategies fit into your long-term plan, reach out to WE Alliance Wealth Advisors. Let’s find the smartest way forward for your family.