We don’t often think about 529 plans as a way to reduce our immediate tax liability, but I was recently talking to a friend of mine who pointed out an interesting strategy that might help him reduce the amount of state income taxes he would owe this year. You can think of it as a sort of 529 Plan Hack.
Traditionally, 529 plans act as a sort of Roth IRA for college. You put money into the 529 for your child’s future college expenses, allow that money to grow over time, and then withdraw that money tax-free so long as you use it for qualified educational expenses. If you start right when your children are born, you can basically get yourself 18-22 years of tax-free growth for education expenses. Considering the fact that the S&P 500 has never lost money over a 20 year period, you’ve got pretty good odds you’ll come out with some tax-free money for your kids by the time they enter college.
The above scenario is the traditional way to use a 529 plan. But a little known fact is that a 529 plan can be opened up in anyone’s name, including your own. This opens up a number of interesting possibilities that most people don’t think about.
Specifically, if you work in a state that offers a tax deduction for 529 contributions, you can potentially funnel some of your income through your 529 plan and then use that income to pay for school. You get a state tax deduction and still pay for your school expenses. When used in this way, it acts sort of like an educational health savings account in that it’s one of the few ways you can get triple tax-advantaged savings – i.e. you pay no taxes going in, no taxes on the growth, and no taxes when you take the money out.
What Is A 529 Plan?
A bit of background might be helpful just in case you aren’t familiar with what a 529 plan is. A 529 is a tax-advantaged account that can be used for qualified educational expenses.
For the most part, 529 plans are run by each individual state. However, you don’t need to open a 529 in the state that you live in. You can actually open it up in any state that you want. For example, I opened up my own 529 plan in New York because they offer Vanguard funds and have really low expense ratios, plus my state offers a state income tax deduction if I contribute into any state’s 529 plan.Â
Related: What Is The Best 529 Plan – A Guide To Choosing Your College Savings Plan
The way the 529 plan works is pretty simple. You fund the 529 with post-tax money. You then invest that money into whatever fund choices your plan offers. Once invested, you can then withdraw the funds tax-free, so long as you use the funds for qualified educational expenses (think things like tuition, rent, and textbooks).
The good thing is that a 529 isn’t limited to just your undergrad education. You can use it for a wide variety of schooling, including graduate school.
Funneling Money Through Your 529 Plan To Reduce Your Taxes
Being able to open up a 529 plan in your own name opens up some interesting, non-traditional uses for the 529. Since you can open up the plan in your own name, you can pay for some of your own schooling expenses right out of it. For most people, it won’t matter all that much since most students probably aren’t earning very much money while they’re in school.
If you’re a law student or business student, however, you could easily earn over $30,000 over the course of a summer. If you’re smart, you’re probably going to use some of that money to pay for your school expenses.
This is where the 529 plan comes into play. If the state that you work in offers a tax deduction, all you need to do is open up a 529 plan and name yourself as the beneficiary. Then, you contribute up to the maximum deduction that your state offers. Since we’re using that money right away, we’ll want to put it into something safe, like a money market account.
By doing this, you’ve now reduced your state tax liability by whatever amount you contributed to your plan. Then, when you have more school expenses, you take the money right out of your 529 plan and pay the bill with it. You pay no state taxes on the money going in or coming out. It’s a win-win for you!
How My Friend Plans To Use His 529 Plan
An example probably will help, so here’s how my friend is planning to use this 529 strategy. He has a big law summer associate position locked up in New York for this upcoming summer. At the time of writing this, a first-year associate at a big law firm in New York starts out at a $180,000 annual salary. Summer associates make the same amount, pro-rated for 10 weeks.  That means my friend stands to make about $3,461 per week or $34,615 for the entire summer.  (I know, that’s a crazy amount of money for someone to make)
Using a tax calculator from SmartAsset, it turns out that his New York state income tax will be about $1,372. New York offers a state tax deduction of up to $5,000 per year for contributions to the New York 529 plan. That goes up to $10,000 per year if you’re married.
My friend plans to open up a 529 plan with New York, name himself as the beneficiary, and contribute $5,000 into the plan. Later in the year, he’ll withdraw the $5,000 and use it to pay his tuition for the upcoming year. Doing this lowers his state taxable income down to $29,615 and reduces his state taxes down to $1,049. That’s $323 in tax savings. And in essence, all he’s doing is funneling money that he would be using anyway through his 529 plan in order to make that money tax-free.
Things To Think About Before Doing This Strategy
You’ll want to make sure you consider the following questions before implementing this strategy:
- Does your state offer a tax deduction for 529 contributions? Obviously, if your state doesn’t offer a state income tax deduction, then there’s no point doing this strategy.
- Is there a holding period? Some plans might require you to keep your money in the plan for a certain amount of time before you can use it. Make sure to double-check how long your plan requires you to keep money in the plan. In New York, it appears that you only have to keep the account open for 10 days. My guess is that, at most, you’d have to keep the plan open for a year, which means most people should still be able to take advantage of this strategy, even with a holding period.
- Make sure to consider the impact of being a resident versus a non-resident taxpayer. This is the thing that might throw a wrench in this strategy. A lot of people live and go to school in one state, but work for a summer in another state. My thought is that this should still reduce your income taxes for the state that you work in, but I’m not quite sure what type of effect this would have on your resident state income taxes. I would think that if you earned no money in your resident state, then it wouldn’t matter and doing this strategy still makes sense.
If you’re in a high earning graduate school field where you can make a lot of money over a summer – law school and business school come to mind – then this strategy is something for you to consider. Someone earning over $30,000 as a student will likely have to spend at least some of that money on school expenses.
Check to see if your state offers a tax deduction for 529 contributions. If it does, consider contributing money to it. It’s an easy way to reduce your tax liability right now and snag a bit of tax-free money too.
Addendum
The great thing about a 529 is that you can use those funds to pay rent. You just can’t exceed whatever your school estimates your room and board expenses should be (sorry, no luxury apartment for you). Everyone has to pay rent, right? At a minimum, it’s not too difficult to funnel some of your income through a 529 and then pay rent with it.
More Recommended Ebike/Scooters
Check out these other ebikes and scooters I've reviewed:
- Urban Arrow Ebike – Last year, I made one of the largest purchases I’ve ever made – I bought a $9,000 electric cargo bike from Urban Arrow. In my Urban Arrow review, I will discuss what it is and why I decided to buy this bike, as well as discuss how impactful a bike like this can be on your journey to financial independence.
- Troxus Explorer Step-Thru Ebike – The Troxus Explorer Step-Thru is a fat-tire ebike that I’ve had the pleasure of riding for a while now. It has amazing power, great looks, and awesome range. If you’re looking for a great fat-tire ebike that offers a lot for the price, the Troxus Explorer Step-Thru is definitely one for you to consider. Check out my Troxus Explorer Step-Thru Review.
- Hovsco HovBeta Ebike – The HovBeta is a folding ebike with great specs and a lot of interesting features, and importantly, it’s sold at a good price point. I’ve had a blast commuting with it and using it to do deliveries with DoorDash, Uber Eats, and Grubhub. Check out my Hovsco HovBeta Ebike Review.
- Vanpowers Manidae Ebike – The Vanpowers Manidae is a fat tire ebike that I’ve been riding as my primary winter commuting bike and have also been using it to do food delivery with apps like DoorDash, Uber Eats, and Grubhub. After clocking in a decent number of miles with this ebike, I wanted to write a post sharing what my experience with the Vanpowers Manidae ebike has been like. Check out my Vanpowers Manidae Review.
- Sohamo S3 Step-Thru Folding EBike Review – A Great Value Folding Ebike – The Sohamo S3 Step-Thru Folding Ebike is an entry-level folding ebike that offers a lot of value for the price point. I’ve been riding the Sohamo S3 for a while now, putting the bike through its paces, and I have to say, this bike has exceeded all of my expectations. Check out my Sohamo Review.
- KBO Flip Ebike – The KBO Flip is an excellent bike. I’ve had a great time riding it and think it’s a versatile bike that can be used for a lot of purposes and can fit a variety of lifestyles. It’s worked out great for me as a general commuter bike and as a food delivery bike. Check out my KBO Flip Review.
- Hiboy P7 Commuter Ebike – The Hiboy P7 is an excellent electric commuter bike that’s offered at an affordable price point. The range and speed of this bike are both very good, so you won’t have any trouble getting anywhere you need to go with it. As a food delivery vehicle, this is also good – with how much range it offers, you’ll be able to work all day on a single charge. Check out my Hiboy P7 Commuter Electric Bike Review.
- Himiway Escape Ebike – The Himiway Escape is an interesting bike for anyone looking for a moped-style ebike. If you’re a gig economy worker, the Himiway Escape is particularly interesting and it’s possible to think of it as an investment, especially if you can opt to do deliveries with the Himiway versus using a car. It’s not cheap, but you can definitely make your money back when you compare the mileage you’ll put on your car versus using an ebike. Check out my Himiway Escape Bike Review.
- Espin Sport Ebike – The Espin Sport is a good ebike for someone who is looking for an ebike that feels and rides more like a regular bike. There are many ebikes that are really only bikes in name. In reality, they’re basically electric mopeds. The Espin Sport, by contrast, is a bike you could probably ride without the battery and you’d feel like you’re just riding a regular bike. Check out my Espin Sport Review.
- Varla Eagle One Scooter – The Varla Eagle One is an excellent scooter that can make sense for a lot of people. It can work as a primary mode of transportation. You can use it to work on gig economy apps like DoorDash, Uber Eats, and Grubhub. And it can also be a recreational vehicle if you’d prefer to use it for that. Check out my Varla Eagle One Review.
- Varla Falcon Scooter – The Varla Falcon is an excellent scooter that offers a good amount of power at a lower price point compared to more powerful scooters. It’s not exactly an entry-level scooter, nor is it a high-powered scooter. I think it fits somewhere in-between those two categories – an intermediate scooter if I had to give it a category. Check out my Varla Falcon Review.
- Hiboy S2 Scooter – The Hiboy S2 is an excellent entry-level commuter scooter that's perfect for someone looking to save some money in transportation costs and improve their commute. Check out my Hiboy S2 Review.
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- Fucare H3 Scooter – The Fucare H3 is a fun scooter and I’ve enjoyed testing it out. For a daily commuter or quick trips or errands, the Fucare H3 is probably the scooter I’ll use. It’s portable and easy to maneuver, so it’s just easier to take on the road when I need it. Check out my Fucare H3 Scooter Review.
More Recommended Investing App Bonuses
For additional investing app bonuses, be sure to check out the ones below:
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- SoFi Money ($275) – SoFi Money is a free checking account from SoFi. They’re currently offering a $25 referral bonus if you open a SoFi account with a referral link and deposit $10. You can also make an additional $250 as well if you complete a direct deposit. This is a good bank that is also 100% free, so you won’t have to worry about managing this account. Here’s a post I wrote with instructions on how to earn your SoFi Money bonus: SoFi Money Referral Bonus: Step By Step Guide.
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- Fifth Third Bank ($350) – This offer is limited to customers in the following states: Florida, Georgia, Illinois, Indiana, Kentucky, Michigan, North Carolina, Ohio, Tennessee, West Virginia, and South Carolina. If you don’t live in one of those states, you won’t be able to open an account online but you can still open an account in-branch if you happen to be visiting a city that has a branch. This is a fairly easy bank bonus to earn, especially since there are plenty of data points showing what will trigger the direct deposit requirement. In addition, you can open the Fifth Third Momentum Checking bank account, which comes with no monthly fees or minimum balance requirements. Read my guide on this bonus here.
- GO2Bank ($75) - GO2Bank is an easy bank bonus that I recommend people take advantage of if they have an easy way of meeting the direct deposit requirement. I like that it’s easy to open the account and that the bonus pays out quickly. Check out my step-by-step guide on how to earn your GO2Bank $75 referral bonus.
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Kevin is an attorney and the blogger behind Financial Panther, a blog about personal finance, travel hacking, and side hustling using the gig economy. He paid off $87,000 worth of student loans in just 2.5 years by choosing not to live like a big shot lawyer.
Kevin is passionate about earning money using the gig economy and you can see all the ways he makes extra income every month in his side hustle reports.
Kevin is also big on using the latest fintech apps to improve his finances. Some of Kevin's favorite fintech apps include:
- SoFi Money. A really good checking account with absolutely no fees. You'll get a $25 referral bonus if you open a SoFi Money account with a referral link, and an additional $250 if you complete a direct deposit.
- 5% Savings Accounts. I'm currently getting 5.25% interest on my savings through a company called Raisin. Opening a Raisin account takes minutes to complete, it's free, and all of your funds are FDIC-insured. I explain how it works, why I'm now using it to store my emergency fund and any other cash savings I have, and why I recommend everyone check it out in this review.
- US Bank Business. US Bank is currently offering new business customers a $800 signup bonus after opening a new account and meeting certain requirements.
- M1 Finance. This is a great robo-advisor that has no fees and allows you to create a customized portfolio based on your risk tolerance. You also get $100 for opening an account.
- Personal Capital. One of best free apps you can use to monitor your portfolio and track your net worth. This is one of the apps I use to track my financial accounts.
Feel free to send Kevin a message here.
My wife and I are both doing to grad school as part time students. We make combined over 250k in VA. We have MBA expenses around 60k per year for both. Do we qualify for this scenario?
You’ll need to check your state rules, but it looks like in VA, you can deduct 4k per year of contributions with unlimited carry forward. But I can’t say for certain in your state because I don’t know how it works in VA.
Hi Kevin,
Great post, I just started following your blog this week. I’ve been researching the benefits of 529.
I currently work full time while also doing my MBA online with one year left. My wife just finished year 1 of pharmacy school.
I am thinking of opening a 529 to pay my tuition & book since I pay out of pocket right now and get reimbursed after each semester by my employer. Do you think the education deduction works for a mortgage as it does for rent?
What strategy will you recommend as far as opening a 529 for my wife, she goes to school in Illinois and pays rent.
I see Missouri allows up to 16k and Illinois up to 20k in the deduction for a married couple filing jointly.
You’ll probably need to look at whether your wife pays Illinois state income taxes. If so, then I’d just do whatever Illinois 529 deduction requirements are.
Interesting. Your 529 plan is the American version of our Canadian RESP (“Registered Education Savings Plan”). In our version, the government gives us a 20% match for whatever we put in there.
I read some where you can you also take money out of your traditional IRA to pay for higher education costs. (the penalty for withdrawing before 591/2 is waived in this case) Is that true?
The Canada RESP sounds awesome! 20% match!? I did some quick googling and it looks like you get a 20% match on up to $2,500, which is amazing! That’s a freebie 500 bucks!
That’s true that you can take money out of a traditional IRA. The only reason it’s not necessarily recommended is because you’re pulling money out of your own retirement. Better to use a separate vehicle to pay for your education and keep your retirement vehicle in another bucket.
That makes sense. Man you guys have so many tax sheltering vehicles, whereas we only have 2 (RRSP, TFSA). I think this is why most FIRE bloggers are American. You have more options to shelter your income and get to FIRE faster. On the flip side, we do have free healthcare, so at least there’s that advantage.
I love this strategy and I’m surprised more people don’t use it. Any parents that are planning to do a pay-as-you-go for their children should also look into using this strategy.
One of the best sites out there for learning more about 529s in your own state is: http://www.savingforcollege.com/college_savings_201/
You can find out if your state offers a tax deduction and/or matching contribution to your 529.
Saving for College is an awesome site! Honestly, the reason more people don’t do this strategy is probably because it’s not really obvious. When I think about a 529, I think about it being for my kids sometime way in the future. You don’t really think of a 529 as a way to funnel money through to avoid state taxes.
We contribute to our kids’ 529 plans here in NY and it’s good to get the tax deduction. It crossed my mind about this hack to contribute even when my kids are in college to get the tax deduction and used that money to pay for tuition. I do need to check the holding period though…didn’t think about that. Unfortunately, I never thought about this when I was in law school and since I went part-time and worked full time during the day, I had some money I could have contributed to my own 529 plan.
The thing I didn’t think about was rent! If you’re in law school, you’re definitely going to have to pay rent. If you can pay some of your rent with tax-free money, why wouldn’t you?
It definitely might be something to consider doing if you’re cash flowing your kids current school expenses (like rent, for example).
I’m pretty sure the holding period isn’t a long time, but I might call the NY 529 people just to double check. The info isn’t really clear.
Fabulous – I never looked into 529s but my BFs kids are almost college age so this caught my eye. I have been thinking of going back to school just to finish my associates! I started flying at 23 and never needed a degree so I didn’t bother to finish. Now that I am on the path to FI I figure I may not be doing this flying gig forever. This strategy would be great for me to fly and go back to school may the same time. Time to look into it! Thanks for a super idea!
Glad it could help! There’s definitely more to it I’m sure. I’m by no means a tax expert, but it seems like this is definitely something a lot of people earning money and paying their way through school could do.
My only comment is:
*Begins Slow Clap*
I often have to investigate fraud, theft, and embezzlement and (important disclaimer: I’m not an attorney!) seems legit! Smart way to use funds on yourself in a manner the state wants you to. The state wants educated people, you want to be educated, keep your would be tax money and drop it into your education. Brilliant!
This is really good if you have to pay for school anyway! If you’re in school and earning some money, it makes complete sense to funnel money that you’re paying towards rent or something through your 529 if your state offers the deduction. My state doesn’t offer a tax deduction, but a lot of people that work for a summer in New York (which is a lot of big law lawyers) could easily utilize this technique to pay for part of their law school expenses.
Interesting scenario and creative use of the 529!
This probably would only work for law students since there really aren’t many other careers where you can rack up a nice salary before graduation. It took me 6 years AFTER medical school before I could generate an income higher than minimum wage.
That being said, if your income bracket is still relatively low, I’d still try to max out my Roth IRA and 401k before working on a 529 for myself. The stakes are much higher once you are in the high income big law firm.
It definitely is limited to a subset of students who earn a significant income during a summer. I just thought it was an interesting scenario that my friend pointed out. For someone in law school (or business school), it makes sense to put some of your summer money to work instead of blowing it all or even investing it. Assuming you’re paying for school yourself, you’re either taking out loans or cash flowing school.
The good thing is that I think 529 funds can be used for reasonable rent costs. You have to pay rent, right? So why not funnel your earnings through the 529 and snag some tax benefits while already paying rent anyway.