What Is a 529 College Savings Plan?

Figuring out how to cover the cost of college for yourself or a loved one can be challenging. If you’re looking for a way to specifically set aside funds for college, a 529 plan is a great option. One of the standout features is the substantial tax advantages they bring. 

These plans provide a tax-free way to build earnings while the funds stay in the account. Additionally, the beneficiary typically doesn’t have to include earnings from the 529 plan as income. 

In this article, we’ll explore the ins and outs of 529 plans. Whether you’re a parent planning for your child’s academic future, a student aiming for financial independence, or someone mindful of education expenses, a 529 plan could be a valuable tool. 

What is a 529 plan?

A 529 plan is a savings plan designed to help people set aside money to cover future education costs. These plans, also called “qualified tuition programs,” are authorized by the IRS. The tax advantages these plans offer help make them a popular savings option.

A couple of key tax benefits of a 529 plan are that you can build earnings tax-free while the funds stay in the account, and the owner and the beneficiary of the funds typically don’t have to include earnings from the 529 plan as income.  

Additionally, distributions from the account typically are not taxed if the funds are used to cover the costs of qualified educational expenses, including higher education expenses and tuition for elementary and secondary schools. 

For these reasons, nearly anyone with education costs may benefit from a 529 plan. State governments and educational institutions sponsor these plans. Nearly every state and Washington DC offers at least one 529 plan (notably, Wyoming doesn’t offer a 529 plan).

Ask the expert

Natalie Slagle

CFP®

We typically recommend funding a 529 plan first before other children’s savings accounts when the goal is to fund future education costs. Not only do you benefit from tax-free growth when utilized for qualified education costs, but you may also get a state tax deduction for the contribution if you live in a state that provides that benefit!

How does a 529 plan work?

A 529 plan can help you save the funds needed to cover the costs of attending college for a specific student—the account’s beneficiary. Not only can anyone generally open a 529 account, but you can also usually name anyone as the account beneficiary—even yourself or someone unrelated to you. 

Some essential things you need to know when considering how a 529 plan works are:

Account beneficiaries

In most cases, anyone who’s a citizen or resident alien of the U.S. can be the beneficiary of a 529 account, even if they’re unrelated to the person who opened the account. Additionally, beneficiaries can have more than one 529 account in their name. 

You’ll need to open a separate plan for each person you want to list as a beneficiary. These accounts are designed to help you save money to cover the cost of a single beneficiary’s qualified higher education expenses. 

Depending on the plan type, there are often no age restrictions, which means it’s not too late or early to open an account. You can even open a 529 account and list yourself as the beneficiary if you want to save for your education.

Remember that the plan requirements can vary, so check with the plan administrator in your state to understand the details and whether any restrictions apply. 

Opening and contributing to an account

You can usually open a 529 account for anyone, even if you aren’t related to the beneficiary. Similarly, you can generally contribute to any 529 account. However, review the details of the 529 plan to see if there are any restrictions.  

Ask the expert

Natalie Slagle

CFP®

Start by looking into your state-sponsored 529 plan. Some states may require you to open their 529 plan to receive the state tax deduction. If that is not the case, and your state-sponsored 529 plan is less than ideal, look to another state-sponsored 529 plan—you do not always need to establish a 529 plan with the state that you live in.

Using the funds

The funds can be used by the beneficiary to pay for qualified expenses associated with their education. Additionally, the funds may be transferred to another family member or saved for use in the future if the beneficiary doesn’t need it all or decides not to go to college. 

Depending on the plan, the account owner can withdraw to pay for qualified expenses in the calendar year in which they were incurred and have the funds sent to themselves, the school, or the beneficiary. 

Make sure to keep good records to document how much of the funds were used to pay for qualified expenses. As long as your withdrawals don’t exceed the qualified expenses, your withdrawals—including what you earned on the money while it was invested—will be tax-free. 

Contribution limits

You can contribute more to a 529 plan than the amount necessary to pay for higher education expenses. There are not typically contribution limits, but you may have to file a gift tax return if you fund an amount greater than the annual gift tax exclusion.

Each state also provides a maximum balance amount. This is typically more than $500,000.

Always check with your plan administration to understand what’s allowed for your specific plan. 

Types of 529 plans 

There are two types of 529 plans: education savings and prepaid tuition. Here’s how each of these plans compare: 

• Education savings plans: Allow you to save for the future qualified education expenses of the beneficiary (e.g., tuition, housing). Funds can be used at any university or college, sometimes even those outside the United States. You can also use funds for elementary and secondary school tuition. 
• Prepaid tuition plans: Allow you to buy credits to cover the future cost of tuition and required fees at participating colleges or universities on behalf of a beneficiary. You can’t use these funds for elementary or secondary school tuition. 

While 49 states (Wyoming is excluded) and the District of Columbia offer at least one type of 529 plan, not all states offer both. Additionally, education savings plans are more common than prepaid tuition plans. 

Ask the expert

Natalie Slagle

CFP®

Always review the administrative and investment fees for the accounts you are interested in, and review the investment options to ensure they are adequate for the risk tolerance you have associated with the 529 plan. A neat feature we’ve been seeing with 529 plans is the ability to easily send information to family or friends on contributing to the account. You typically provide them a code associated with your account, and they can contribute without having access to log into the account. Clients enjoy this around the holidays and birthdays for their little ones!

Where are 529 plans available?

Most states and the District of Columbia sponsor 529 plans (notably, Wyoming is excluded from this list). However, you can invest in nearly any state-sponsored 529 education savings plan, even if it’s located outside the state where you reside. You can even invest in multiple plans. 

Investing in 529 savings plans outside your state is helpful, enabling you to find a plan that’s right for you and your family. You can easily search for and compare 529 plans with the College Savings Plans Network tool, a National Association of State Treasurers affiliate.

For prepaid tuition plans, the account holder or the beneficiary typically needs to be a resident of the state where the plan is administered when the account is opened. Check with the plan administrator to understand the details if you want to open a plan outside your state.

This can vary while prepaid tuition plans are generally designed for public, in-state colleges and universities. Your plan administrator can provide the details. For savings plans, qualified education expenses at any school—sometimes even those outside the U.S.—are usually covered.

529 college savings plan FAQ 

How does a 529 plan affect my child’s chances of qualifying for financial aid?

A 529 plan can impact your child’s eligibility for need-based financial aid because 529 plan assets are considered parental assets on the Free Application for Federal Student Aid (FAFSA). 

The Expected Family Contribution (EFC) calculation considers up to 5.64% of the assets. This doesn’t eradicate chances for aid completely, but it could reduce the aid your child is eligible for.

Are there any tax implications for the contributor or beneficiary?

Contributions to a 529 plan grow tax-deferred, and distributions used for qualified education expenses are tax-free. Even states sweeten the deal with tax deductions or credits for contributions. 

However, any nonqualified withdrawals can attract taxation and a 10% federal penalty. Using the proposed funds for qualified education expenses can help you avoid these outcomes.

What happens to the 529 plan if my child earns a scholarship?

You can take out funds up to the scholarship amount from your 529 plan without facing any penalties. 

Remember the tax benefits: The withdrawn earnings remain taxable. You can also switch beneficiaries to use the money for further education without any tax implications. In essence, scholarships don’t hamper your 529 plan accumulations.

What happens to the 529 funds if they’re not used?

You have options if your child chooses not to pursue postsecondary education or otherwise doesn’t use the 529 funds. You may:

• Change the beneficiary to another qualifying family member and save the money. 
• Withdraw the money but lose the tax advantages
• Keep the money in the plan indefinitely, waiting for possible use by future grandchildren. 
• Roll over a lifetime limit of $35,000 in unused 529 funds to a Roth IRA without incurring the 10% penalty.