Whether you’re a parent, grandparent, or guardian, planning for your loved one’s education is a crucial step towards their future success. In this article, we’ll break down what you need to know about 529 plans, from how they work to their tax benefits and impact on financial aid.

What is a 529 Plan?

A 529 plan is a state-sponsored, tax-advantaged method to invest substantial assets towards education costs.

Who can create a 529?

An account holder (typically a parent or guardian) sets up a 529 plan account for a designated beneficiary (usually a child, grandchild, or yourself). Everyone can use a 529 plan because there are no restrictions on annual income. Plus, unlike some education savings accounts like the Coverdell ESAs, there is no time limit or beneficiary age when you have to spend it.

Where are 529 plans sold?

The 529 College Savings Plan comes in two primary forms: broker-sold and state-sponsored. Both types offer a tax-advantaged way to save for education, but one of the key advantages of is the potential for additional tax benefits. Many states offer tax deductions or credits for contributions made to their own 529 plans, providing an extra incentive for residents to save for education.

Where is the money invested? The funds in the 529 plan are typically invested in a variety of investment options, such as mutual funds. Some plans offer age-based investment options that automatically adjust the asset allocation as the beneficiary gets closer to college age. Most 529 plans have high contribution limits, such as more than $200,000 or $300,000 per beneficiary. That allows you to save as little or as much as you need for your or a child’s education from kindergarten to graduate school.

What about taxes? One of the primary benefits of a 529 plan is its tax advantages. The investment earnings in the account grow tax-free, and qualified withdrawals for education expenses are also tax-free at the federal level if you spend them on qualified education expenses. Some states offer tax incentives for contributions, such as deductions or credits. A 529 college savings plan allows you to name and save for a future student or beneficiary, such as a child or yourself. You contribute and choose investments from a menu similar to a retirement account. Most states offer at least one 529 plan; however, the fees and benefits vary, such as the maximum contribution limit and investment options. You typically don’t have to be a state resident to participate in its plan, but many states offer deductions for contributions to a 529 plan- we’ve outlined the state specific tax deduction for 529 contributions here.

What costs are covered? Qualified education expenses that can be paid for using funds from a 529 plan typically include tuition at eligible colleges, universities, vocational schools, apprenticeship programs, special needs education, study approach, and some 529 plans allow funds to be used for K-12 tuition expenses, up to a certain limit. Other fees include room and board, books and supplies, computers and internet access, tutoring, transportation, repayment of student loans and more… While 529 plans offer significant tax advantages for qualified educational expenses, it’s essential to understand that not all expenses are eligible for tax-free withdrawals. Expenses such as insurance, student loan interest, and certain extracurricular activities are generally considered non-qualified expenses.

It’s important to note that non-qualified withdrawals from a 529 plan may be subject to federal income tax and a 10% penalty on the earnings portion. However, there are exceptions to the penalty, such as scholarship.

What about unused funds? If you have unused 529 funds, but no beneficiary that plans to use them, cashing out is an option. However, you’ll owe tax on the earnings portion, plus a 10% penalty.

Another new option created by SECURE 2.0 called the 529-rollover-to-Roth-IRA began in 2024 allowing you to move a certain amount of unused 529 funds to your Roth IRA.

What about younger students? 529 funds can also be used for younger students, a relatively new benefit in the Tax Cuts and Jobs Act of 2017. It expanded qualified education expenses to include tuition for kindergarten through high school for up to $10,000 per student annually.

You can spend the money in your 529 plan student account on public, private, or religious school expenses.

How does a 529 plan impact Financial Aid? With a 529 Plan, only a maximum of 5.64% of the account’s value is factored into the Student Aid Index (SAI), which determines eligibility for need-based financial aid. This treatment is more favorable compared to assets held in the student’s name, which are assessed at a higher rate (up to 20%) (Read more here). ​​While a parent-owned 529 plan is a component of federal financial aid calculations, it’s a relatively small amount compared to other accounts. For instance, savings owned by a future student such as a UTMA/ UGMA custodial account or a Roth IRA, count more toward the Student Aid Index for financial aid.

Can multiple people contribute to a 529 plan? Yes, multiple people can contribute to a 529 plan. In fact, contributions from various sources help fund a beneficiary’s education. A 529 plan offers unique gifting features that can amplify the investments over time. Those contributing to the plan may also be eligible for state tax deductions for contributions.

In conclusion, a 529 College Savings Plan offers families a tax-efficient way to save for education expenses, from elementary school to college and beyond. With its potential for tax-free growth and withdrawals, along with minimal impact on financial aid eligibility, a 529 plan is a powerful tool for building a brighter future for your loved ones.

Continue to learn more from our 529 Plans 101 series.