Great South Bay Advisors: Planning Ahead for College: A Guide to New York's 529 Plan

Last week, a longtime client called me shortly after making the first tuition payment for their oldest child. They wanted to thank us for a recommendation we made in 2011: open a 529 College Savings Plan for each of their children and contribute steadily every month. Today, those savings will cover four years at one of the country's top private universities, and because the money is going toward qualified education expenses, they can withdraw it completely tax-free. Any funds left over could even give their son a head start on retirement savings.

The very next day, I finalized the paperwork for a client and friend opening a 529 plan for their newborn daughter. Much of my work involves small decisions whose results unfold gradually over many years. Helping a family save for college, like helping a client reach a comfortable retirement, is one of the rare times we get to see the benefits of our advice so tangibly. Calls like that are one of my favorite parts of this career, and I look forward to many more.

Pursuing higher education (in all its forms) brings real benefits, both measurable and intangible, but paying for it "out of pocket" is increasingly out of reach for all but the wealthiest families. The College Board estimates that a child born in 2025 will spend an average of over $268,000 to attend a four-year in-state public university, and over $631,000 at a private one. With costs growing much faster than inflation, families need to think strategically.

For many, tuition and room and board are only the tip of the iceberg. Over the last twenty years, Americans' student loan debt has ballooned an astonishing 343%, leaving many borrowers facing decades of payments that damage their credit, delay homeownership, and weigh on their financial and psychological well-being. Families have several ways to reduce the burden. Merit- and need-based financial aid can lower costs significantly. Scholarships are appealing but too uncertain to count on; only about 2% of high school athletes receive athletic scholarships to play in college, and most of those cover only part of the cost. Starting at a community college or earning college credits in high school are more dependable options. Even so, most families will need to pay for at least part of college themselves. Fortunately, one account offers families who plan ahead significant tax advantages: the 529 College Savings Plan.

Federal legislation created 529 plans in 1996, and the rules have been refined many times since. Each state runs its own plan, so tax benefits, investment options, and other features vary. This column covers New York's plan and assumes the reader lives in New York when opening the account.

One of the key benefits of these plans is a state income tax deduction. New York account owners can deduct up to $5,000 in contributions per year if single, or $10,000 if married filing jointly. The limit applies per taxpayer, not per student, so a married couple with three children can still deduct only $10,000 per year. Contributions above the limit aren't deductible but still receive the plan's other tax benefits. The deduction belongs to the account owner (and spouse, on a joint return), so a grandparent's gift to a parent-owned account doesn't give the parent a deduction. A grandparent who pays New York State tax may do better opening an account in their own name.

The second benefit is tax-free growth. Earnings grow tax-deferred, and withdrawals are free of both federal and New York income tax when used for qualified expenses, including tuition, fees, room and board, books, and computers at eligible colleges and universities in the United States and at many schools abroad. 529 money isn't limited to four-year degrees: trade and vocational schools eligible for federal student aid, including programs for welders, electricians, plumbers, and HVAC technicians, qualify, as do registered apprenticeship programs. Withdrawals can also repay up to $10,000 in student loans per person over a lifetime, for the beneficiary or a sibling, or be rolled into an ABLE account, a tax-advantaged savings account for people with disabilities. New York has adopted most of these expanded uses in just the last several years. While recent changes to federal tax law have allowed for federally tax-free withdrawals for K-12 educational expenses, New York taxpayers will still pay taxes and penalties at the state level — a situation that continues to evolve, and one we expect further clarity on in the near future. While withdrawals for qualified educational expenses receive tax-exempt treatment, withdrawals for non-education purposes are penalized harshly. The earnings are subject to federal income tax and generally a 10% federal penalty, and New York taxes both the earnings and any previously deducted contributions. However, there are sensible exceptions, including withdrawals up to the amount of a scholarship the student receives, or when a student is accepted to a military academy and is not required to pay tuition.

Due to these penalties, parents sometimes worry about saving too much, but leftover money is more flexible than many people realize. There are no age limits or required withdrawals, so the funds can stay invested for graduate school. The beneficiary can also be changed to another family member, such as a sibling, a cousin, or even a future grandchild, with no tax consequences. Since 2024, unused funds can also be rolled into a Roth IRA for the beneficiary, and New York treats these rollovers as qualified. The account must have been open for at least 15 years, and contributions from the past five years (along with their earnings) can't be moved. Each year's rollover counts toward the beneficiary's annual IRA contribution limit and requires earned income, and lifetime rollovers are capped at $35,000. Roth income limits don't apply. Due to these restrictions, opening an account early can provide important flexibility later on.

529 plans also have estate planning benefits. Contributions are allowed until a beneficiary's combined New York 529 balances reach $520,000. A donor can use five years of annual gift tax exclusions at once, currently up to $95,000 per beneficiary or $190,000 for a married couple, moving the money out of the donor's taxable estate while keeping control of it. If the donor dies before the five years are up, part of the gift is added back to the estate. New York has no gift tax, but for state estate tax purposes it can add back gifts made within three years of death, so older donors considering large contributions should consult an estate attorney.

The account owner, not the student, controls the money regardless of the student's age and can name a successor owner. New York law generally protects 529 accounts from creditors. For financial aid, parent-owned accounts have only a modest effect on federal aid eligibility, and accounts owned by grandparents or other relatives aren't counted at all. Recently, New York has rolled out a system called "UGift," which allows family and friends to make contributions to a 529 plan online using their debit or credit card, making it as easy as buying something from an online retailer. Everyone loves the idea that their gift will grow substantially over time and support a child's education.

The family who called me last week didn't do anything complicated. They made a simple decision 15 years ago that gave their son a remarkable gift: they started early, contributed consistently, and gave tax-advantaged growth time to work. Graduating from college with as little student loan debt as possible provides an incredible head start on a successful life. Whether your child is a newborn or already in middle school, the best time to start is now. As with many financial planning decisions, there are various factors to consider, and we recommend speaking with a fiduciary wealth management professional before making a decision.

Robinson Crothers is Managing Partner at Great South Bay Advisors in Holbrook. This column is for general educational purposes and is not individualized investment, tax, or legal advice. Securities and investment advisory services offered through Osaic Wealth, Inc., Member FINRA/SIPC. Great South Bay Advisors and Osaic Wealth, Inc. are not affiliated.