Saving for a Child's Education: What California Law Does Differently

Almost everything written about 529 plans describes federal law. That is fine until you file a California return, because California follows some of those federal rules and pointedly declines to follow others. A withdrawal that is perfectly qualified on a federal return can be taxable in California and carry an additional 2.5 percent state tax on top.

The gap has widened rather than closed. Congress expanded what 529 money can be spent on effective January 1, 2026, and the Franchise Tax Board has confirmed California does not conform to those changes. Families who read a national article and act on it are the ones who get surprised.

This is a piece about legal and tax structure—who controls the money, how the gift tax treats it, what happens to the account when the owner dies, and where California parts company with the IRS. Which plan to use and how to invest inside it is a conversation for a financial advisor. What follows is the part that ends up in an estate plan.

Where California Stops Following Federal Law

Start with the item most families assume they have and do not. California offers no state income tax deduction or credit for contributing to a 529 plan. Roughly thirty states give one; California is not among them. Contributions are made with after-tax dollars for both federal and state purposes, and the benefit is entirely in the tax-free growth.

The conformity gaps are more consequential, because they turn a tax-free withdrawal into a taxable one:

• K-12 expenses. Federal law permits 529 withdrawals for K-12 costs, and effective January 1, 2026 the annual limit rose from $10,000 to $20,000 per student, with the categories broadened well beyond tuition to include curriculum materials, tutoring, standardized test fees, dual-enrollment courses, and educational therapies. California does not conform to any of it. The earnings portion of a K-12 withdrawal is subject to California income tax plus the additional 2.5 percent state tax.
• 529-to-Roth IRA rollovers. SECURE 2.0 allows up to $35,000 in lifetime rollovers from a 529 to a Roth IRA owned by the beneficiary, provided the account has been open 15 years, contributions from the last five years are excluded, the beneficiary has earned income, and the transfer stays inside the annual Roth contribution limit. California treats the rollover as a nonqualified withdrawal—state income tax on the earnings, plus the 2.5 percent additional tax.
• What California does cover. Higher education expenses at eligible institutions, registered apprenticeship programs, and repayment of qualified education loans up to a $10,000 lifetime cap are qualified for both federal and California purposes.

The practical rule for a California family is narrower than the federal one: use 529 money for college, apprenticeships, and student loans within the cap, and treat K-12 withdrawals and Roth rollovers as decisions with a state tax cost attached. That cost is not always disqualifying—but it should be calculated first rather than discovered in April.

The Gift Tax Rules Behind a Contribution

A contribution to a 529 plan is a completed gift of a present interest to the beneficiary, which means it qualifies for the annual gift tax exclusion—$19,000 per recipient in 2026. A married couple can double that to $38,000 per beneficiary without touching the lifetime exemption or filing anything.

There is also a front-loading provision unique to 529 plans. Internal Revenue Code section 529(c)(2)(B) lets a donor treat a single large contribution as though it were made evenly over five years. In 2026 that permits $95,000 per beneficiary from one donor, or $190,000 from a married couple, with no gift tax and no use of the lifetime exemption. The election is not automatic—it has to be made on a timely filed Form 709 for the year of the contribution.

The trap is what happens if the donor dies inside the five-year window. Under section 529(c)(4)(C), the portion allocated to years after the death is pulled back into the donor's gross estate. Contribute $95,000 in year one and die in year two, and roughly $57,000—the share allocated to years three through five—returns to the estate. The contribution is not undone and the beneficiary keeps the account; it is purely an estate tax computation. For donors in poor health or advanced age, spreading contributions across actual years rather than electing the five-year spread avoids the issue entirely.

The Estate Planning Feature Nobody Talks About

Here is what makes 529 plans genuinely unusual, and it has nothing to do with education. Under section 529(c)(4)(A), the account is excluded from the donor's gross estate—while the donor keeps control of it.

The account owner can change the beneficiary, direct the investments, and even take the money back, subject to tax and penalty on the earnings. In virtually any other context, that degree of retained control pulls the asset straight back into the taxable estate under the retained-interest rules. Section 529 carves out an exception.

That combination is why 529 plans show up in estate plans for reasons that have little to do with tuition. A grandparent can move meaningful value out of a taxable estate, retain the power to redirect it if a grandchild does not attend college, and never file a gift tax return if contributions stay inside the annual exclusion. Few other structures offer removal from the estate and retained control at the same time.

One caution attaches to the beneficiary-change power. A change to a member of the beneficiary's family under section 529(e)(2) is tax-free, but a change to someone in a lower generation—grandchild to great-grandchild—can trigger generation-skipping transfer tax consequences. It is worth checking before making the switch.

The Unlimited Exclusion Most Grandparents Never Use

Families focused on the $19,000 annual exclusion routinely overlook a separate provision that has no dollar limit at all.

Internal Revenue Code section 2503(e) excludes from gift tax entirely any payment of tuition made directly to an educational institution on behalf of a student. Not limited to $19,000. Not limited to any figure. It does not consume the annual exclusion, and it does not reduce the lifetime exemption. A grandparent can pay a $70,000 tuition bill and separately give the same grandchild $19,000 in the same year, with no gift tax return required for either.

The requirements are strict and unforgiving:

• The payment must be for tuition only. Room and board, books, supplies, and fees do not qualify—those are ordinary gifts subject to the annual exclusion.
• The payment must go directly from the donor to the institution. Writing the check to the parent or the student to forward defeats the exclusion completely, even if every dollar reaches the school.
• The recipient must be an educational organization described in section 170(b)(1)(A)(ii)—one with a regular faculty, curriculum, and enrolled student body. Private elementary and secondary schools qualify, so this is not limited to college.
• The donor need not be related to the student.

The most efficient approach for grandparents with taxable estates is usually to combine the two: pay tuition directly under section 2503(e), and use annual exclusion gifts or 529 contributions for the expenses tuition payments cannot cover. Done consistently over several years, that moves substantial value out of an estate without ever filing a gift tax return.

Who Actually Controls the Money

The three common structures differ mainly in who holds the money and when the child can reach it, and that difference matters more than the tax treatment for most families.

A 529 plan leaves control with the account owner permanently. The beneficiary has no legal right to the funds and cannot demand them at any age. If a child skips college, joins the military, or simply turns out not to need the money, the owner redirects the account to another family member.

A custodial account under the California Uniform Transfers to Minors Act is the opposite, and this is where families get caught. The transfer is an irrevocable gift—the money legally belongs to the child from the moment it is made, and the custodian merely manages it. Under Probate Code section 3920 the custodianship ends when the minor turns 18 by default. A later age applies only if the original transfer said so: up to 21 for a lifetime gift under section 3904, and up to 25 where the property was transferred by a trustee under section 3906. If nobody specified an age when the account was opened, an 18-year-old is legally entitled to the entire balance and may spend it on anything at all.

A trust gives the most control and costs the most to create and maintain. It can condition distributions on enrollment, spread them across siblings according to actual need rather than equal shares, continue past age 25, and hold back funds from a beneficiary with creditor problems or an addiction. Trusts pay income tax at compressed rates, so they are generally reserved for larger amounts or for circumstances that genuinely require the control.

What Happens to the Account When the Owner Dies

This is the question that belongs in an estate plan and is almost always missed, because a 529 plan does not behave like the accounts around it.

Most plans allow the account owner to name a successor owner, who takes over control on the owner's death. If no successor is named, what happens depends on the plan's own terms and on the owner's estate documents, and the account can end up in probate—an odd result for an asset that was excluded from the taxable estate in the first place.

Naming a successor owner takes a few minutes on the plan's website and is one of the highest-value items on any funding checklist. Grandparents in particular should confirm that the successor is someone who will actually use the account for the grandchild, since the successor owner inherits the full power to change the beneficiary.

Two related points. A 529 account is not controlled by your revocable trust unless the ownership question is addressed deliberately, so listing it on a trust schedule accomplishes nothing on its own. And where a grandparent has funded accounts for several grandchildren, the estate plan should say what happens if the accounts are unequal at death—an issue that produces real friction among siblings when nobody addressed it in advance.

Financial Aid and the Grandparent Question

The old advice was that grandparents should not own a 529, because distributions counted as untaxed student income on the FAFSA at an assessment rate as high as 50 percent—a $20,000 distribution could cut aid by $10,000. That rule is gone. Under the simplified FAFSA, distributions from grandparent-owned and other non-parental 529 accounts are no longer reported as student income.

What remains is the asset side. A parent-owned 529 is reported as a parental asset and assessed at a maximum of 5.64 percent, while assets owned by the student—including a custodial UTMA account, which legally belongs to the child—are assessed at roughly 20 percent. That contrast is one more reason the choice between a 529 and a UTMA deserves thought before the account is opened rather than after.

When to Get Legal Help

Education funding crosses into estate planning as soon as the amounts get large, more than one generation is involved, or the money is meant to outlast the person providing it.

It is worth a conversation when a grandparent is considering a five-figure contribution or the five-year gift tax election, when accounts have been opened for several grandchildren and nobody has confirmed the successor owners, when a custodial account is approaching a termination age the family did not choose deliberately, when a beneficiary is not going to use the funds as intended, or when education money needs to be coordinated with a trust so that one grandchild's tuition is not quietly funded twice.

Andrews Law Firm helps families in Truckee, Tahoe City, and throughout the Sierra Nevada region structure education gifts as part of a complete estate plan—coordinating 529 accounts, custodial accounts, direct tuition payments, and trust provisions so they work together rather than at cross purposes. Contact us to schedule a consultation.