What is a 529 plan?

A 529 plan is a specialized savings account specifically designed to help pay for college-related expenses. These accounts enable you to save tax-deferred money that can be later withdrawn tax-free to pay for student loan repayments, college and K-12 tuition, and other educational expenses. 

For these reasons, they are a popular investment option for families who want to save for college but who may not have the money to completely cover all their expenses.

In this article, we’ll explain what a 529 plan is, how it works, and the benefits of using this type of account to save for college tuition and expenses.

What’s the purpose of 529 plans?

Named after Section 529 of the federal Internal Revenue Code (IRC), 529 plans are administered at the state level to assist families in saving for future educational expenses. 

Parents or grandparents often establish 529 accounts on behalf of a child and contribute funds to be withdrawn later for education-related costs. Money deposited in 529 plans grows tax-deferred. And depending on the state, account owners can deduct 529 contributions on their state tax returns.

In recent years, expenses covered by the 529 have expanded to include K-12 education, apprenticeship programs, and even student loan repayments.

Types of 529 plans

There are two types of 529 plans: college savings plans and prepaid tuition plans. 

Education savings plans

College savings plans are what most people think of when they hear about 529 plans. They work by investing after-tax contributions in stocks, bonds, or a mix of other investment options you choose. 

The balance may grow during the life of the beneficiary until they are ready for college. They can then withdraw the funds tax-free and use them for qualified educational expenses. 

But what if the beneficiary doesn’t end up pursuing higher education? Well, if the account is at least 15 years old, up to $35,000 of unspent funds can be rolled over into a Roth IRA account throughout the beneficiary’s lifetime. Note that there’s an annual rollover limit that matches the annual Roth IRA contribution limit (which is $7,000 for 2024 for those under 50), meaning it can take several years of contributions to reach that $35,000 lifetime limit.

Prepaid tuition plans

Prepaid tuition plans are a less common version of a 529 plan. They allow you to pre purchase all or part of tuition costs for an in-state public college. You can also transfer your investment to a private college 529 plan that is sponsored by more than 250 private and out-of-state colleges.

These plans are beneficial because they lock in current tuition rates, protecting families against the rising cost of education. However, some come with hefty premiums, do not cover some expenses such as books or room and board, and are not guaranteed by the state. Due to this lack of flexibility, the vast majority of people opt for college savings plans instead. 

529 plan tax advantages

What is the benefit of a 529 education saving plan? Above all, it’s that you can withdraw any growth on your investment funds entirely free of federal and state income taxes. Thanks to the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, tax-free withdrawals up to $10,000 can be used for student loan debt repayment as well. 

As an added bonus, more than 30 states offer tax deductions or tax credits for contributions made to a 529 plan. Also, all contributions to a 529 plan grow tax-deferred, meaning earnings are not subject to federal tax on interest, dividends, or capital gains each year they remain in the account. 

Pros and cons of 529 plans

What makes 529 college savings plans a unique investment option is their flexibility and tax benefits, which aren’t typical of other account types. Being knowledgeable about their pros and cons ensures you use your 529 account to the fullest.

Pros	Cons
Tax benefits	Penalties for nonqualified withdrawals
Full control of funds (owner)	Lack of control of funds (beneficiary)
Beneficiary flexibility	Limited investment options
Extensive range of options	Fees and expenses
High contribution limits	Count against your eligibility for aid

529 plan advantages

• Tax benefits: The account grows tax-deferred, meaning you won’t pay taxes on earnings each year, and withdrawals for qualified education expenses are tax-free.
• Full control of funds (owner): You have 100% control over when and how you withdraw the funds. The child can only access the account if you transfer it to their name.
• Beneficiary flexibility: You can change the beneficiary if the original child chooses not to attend college or decides they don’t want the funds for any reason.
• Extensive range of options: You have a wide variety of 529 plans to choose from, regardless of where you live, your household income, or where your child attends college or university.
• High contribution limits: As of 2024, there is no annual contribution limit for 529 plans, but contributions are subject to IRS gift tax rules. Each state sets its own maximum aggregate contribution limit, typically ranging from about $235,000 to $575,000 per beneficiary. 

529 plan disadvantages

• Penalties for nonqualified withdrawals: Withdrawals for noneducational reasons are unqualified and will face a 10% penalty. They’re also subject to income tax.
• Lack of control of funds (beneficiary): What’s a benefit for the owner is a downside for the beneficiary. The plan owner can liquidate the account or change the beneficiary at any time, as the beneficiary has no legal control over the funds.
• Limited investment options: Often, 529 plans offer a limited range of investment options since you must choose from the portfolio your plan offers.
• Fees and expenses: Many 529 plans come with various fees and expenses, such as management and administration fees, investment expenses, and sales charges.
• Counts against your eligibility for aid: Funds in a 529 plan count against a student’s eligibility for financial aid since they factor into the aid calculation process.

How 529 plans work

Now that you understand what the benefits of a 529 college savings plan are, it’s smart to keep an eye out for tax regulations, fees, and other important rules. Once you have a clear idea of how they work, you can set yourself up for success by correctly using your 529 savings account and avoiding fees.

1. Choose a 529 plan

Before you open an account, research the 529 plans available in your state and other states, as they may have different fees and offer different tax benefits and investment options. 

If you don’t like your state’s options, you can invest in any state’s 529 plan, even if you don’t live there and your child won’t go to school there. Shop around for the best option.

2. Open an account

Once you’ve chosen a suitable plan, you can open an account and designate the beneficiary. This person is whom you’re saving for, whether it’s a child, grandchild, or even yourself if you plan to pursue higher education.

The beneficiary cannot access the account unless you transfer it to their name. This can only happen once they reach the age of majority. You can change the beneficiary later if the original one decides not to attend college.

3. Contribute to your plan

Anyone can contribute to a 529 plan, but starting as early as possible is recommended to allow your investment to grow. The amount that every family needs to save will vary based on the child’s age and the cost of college.

The maximum lump sum contribution allowed before a gift tax is applied is $18,000 per beneficiary per year (in 2024). However, thanks to the five-year gift tax averaging provision, you could contribute a lump sum of up to $90,000 (or $180,000 for married couples) without being subject to the federal gift tax. The provision treats the one-time contribution as if it were given over five years. You’d have to file a gift tax return and avoid contributing gifts to that beneficiary for the next five years.

4. Decide how to invest your money

When it comes to how you want to invest, you have two options: static funds and dynamic investment options. Static funds include stocks, bonds, real estate funds, money market accounts, and more. You can mix these according to your preference.

Dynamic investment options are based on the beneficiary’s age. These start off aggressively investing in stocks and higher-risk options. They then automatically and gradually shift to a steadier, low-risk option as the child reaches college age.

5. Withdraw your money

The account owner may withdraw money at any time, tax-free, and use it for qualified distributions. Any withdrawals for unqualified reasons will face a 10% penalty tax. To avoid penalties, withdraw only what is necessary at any given time. For instance, if tuition for one semester is due at the beginning of the school year, withdrawing funds for the entire year could trigger a penalty.

Here’s a list of qualified expenses:

• Tuition and fees for college, university, or vocational school
• Room and board
• Books, supplies, and equipment required for coursework
• Computers, software, and internet access
• Student loan repayments (up to $10,000)

Knowing what a 529 plan is is a fundamental step toward building your financial literacy. When you see your child walk the stage and get their diploma, you’ll know you helped set them up for success—and that investing in a 529 plan was well worth your time. Interested in helping your child or teen learn more about financial wellness? Check out Intuit for Education, our free, self-paced financial literacy curriculum today.