Advisors Rethink 529 Plans After SECURE 2.0, FAFSA Changes

Financial advisors are moving focus from promoting 529 plans to managing the new rules that affect account use. SECURE 2.0 allows up to $35,000 in lifetime transfers from a 529 to a Roth IRA if the 529 has been open at least 15 years and other eligibility conditions are met. FAFSA rules now exclude distributions from grandparent-owned 529 accounts from the student income calculation. Federal law raised the annual K-12 private tuition withdrawal limit from a 529 to $20,000.

Advisors report the changes reduce concerns about permanently trapped balances in 529 accounts. The SECURE 2.0 rollover creates a retirement outlet for unused funds subject to its eligibility rules. The scholarship exception lets account owners withdraw an amount equal to a scholarship without the 10% penalty on nonqualified withdrawals; earnings on those amounts remain subject to income tax.

The FAFSA revision has estate-planning implications. Grandparents can use the five-year gift-tax election to make large contributions while removing assets from their taxable estates. For 2026, that election permits treating up to $95,000 per individual and up to $190,000 for a couple as completed gifts when spreading a contribution over five years. Because distributions from grandparent-owned accounts are excluded from the student income calculation, those gifts do not directly increase the beneficiary’s federal student income figure.

Advisors identify operational rules that affect how families use 529 accounts. Qualified education expenses and reimbursements from a 529 must occur in the same calendar year to avoid treatment as a nonqualified withdrawal, which can trigger taxes and penalties. Most 529 plans limit investment allocation changes to two per calendar year, reducing flexibility for short-term reallocations compared with taxable brokerage accounts.

State tax treatment varies by jurisdiction. Some states offer tax parity, letting residents claim state tax benefits even when using another state’s 529 plan; Arizona and Kansas provide parity. Other states may recapture prior state tax deductions if assets move to an out-of-state plan; New York has been cited for that risk. Advisors review state-level rules before recommending rollovers or plan changes.

For large surpluses, commonly used options include changing the beneficiary to a later generation, planning taxable withdrawals into wealth-transfer strategies, or keeping assets in the account for completed-gift treatment to reduce estates. Advisors are focusing on timing reimbursements, monitoring state tax exposure, and coordinating 529 accounts with retirement and estate plans to ensure rule compliance and proper tax treatment.