The Ultimate Guide to Saving for College and Beyond With a 529 Plan

Reviewed by Robin Hartill, CFP®
A father lays on the couch with his son and daughter.
Getty Images


If there’s a child in your life whose college education you have yet to fund, there’s a good chance you’ve had moments of panic.

Millions of Americans are carrying a combined $1.7 trillion in student loans, tuition costs are still on the rise — but no one wants their kid to be buried in debt.

The good news is that there’s an investment vehicle specifically designed for education expenses: the 529 savings plan. They offer tax-free growth and tax-sheltered withdrawals for many education expenses. If you start investing soon enough, you can reach savings figures that may seem overwhelming at the start thanks to compound earnings.

If you know you’ll have a lot of education expenses in your future, you will probably like these plans. But before you go open an account, it’s important to know how they work.

What Is a 529 plan?

A 529 plan is an investment account that’s designed specifically to provide you with tax relief as you save for education expenses. This means that if you’re saving money specifically for education expenses, they’ll probably appeal to you.

The plans are sponsored by the states themselves, state agencies or educational institutions.

Each 529 account has an owner and a single beneficiary, and anyone age 18 or older can open one. That means if you’re at least 18, you could open your own account and make yourself the beneficiary. More commonly, though, the beneficiary will be a child or grandchild.

Families with multiple children will need to open separate accounts for each child, though money can be transferred between these accounts without penalty.

There are actually two types of 529 plans: prepaid tuition plans and education savings plans. Here’s how each one works.

Prepaid Tuition Plans

A prepaid tuition plan allows you to “lock in” current tuition rates by purchasing credits at participating colleges and universities.

Contributions to these plans are invested by the program you buy into. The programs invest your money in hopes that the earnings will outpace rising tuition costs.

While 18 states once offered such plans, that number is down to just nine as of 2021.

For your investment to be guaranteed, the state must agree to bail out the prepaid tuition program in the event that the program’s investment goes south. Only six states currently make that guarantee.

Many plans penalize you if your funds are used for out-of-state tuition. Many also require that the beneficiary be at least 15 years old and participate in the plan for three years before you can begin taking distributions.

529 College Savings Plans

The other 529 plan, an education savings plan, is a more typical investment vehicle. If you open one of these accounts, you will be responsible for investing the funds, and you will later be able to use those funds tax-free for qualified educational expenses — more information on that to come.

The Tax Cuts and Jobs Act of 2018 changed the rules so that these plans can even be used to fund private elementary or secondary school tuition. You can withdraw up to $10,000 per student per year without penalty for such expenses.

With education savings plans, you don’t have to participate in your home state, or even the state your child will end up going to school.

Commonly Asked Questions About 529 Plans

A toddler hugs her grandmother.
Getty Images

You should speak with a financial professional before making any decisions that will impact your family’s future. We can’t account for the specifics of your circumstance.

That said, here are our answers to some commonly asked (read: simple) questions about 529 plans.

Who Can Contribute?

A beneficiary does not have to be a dependent of the account’s owner, so friends and family are all free to open an account for a child. If an account is already open for the child, though, there’s no need for a second — you do not have to be the account’s owner to contribute.

You can contribute to these plans no matter what your income.

While anyone can contribute to a plan, the owner of the account will be the only one who has control of the assets, including how the funds will be invested.

How Much Can You Contribute

There is no contribution limit to these accounts. However, some states have a maximum balance ranging from $235,000 to over $500,000.

If you keep your contributions under $15,000 per child per year, you won’t have to deal with federal gift tax consequences. For single lump contributions, you can “superfund” by contributing up to $75,000 per beneficiary in a single year. This will use up five years’ worth of your federal gift tax exemptions as the contributor. However, it’s highly unlikely that you’ll have to worry about gift tax consequences.

Do 529 Plans Affect Financial Aid Eligibility?

As a result of 2018 legislation, 529 funds are now considered assets of the account holder (usually the parent), not their beneficiary (usually the child).

That means 529 plan investments have less impact on financial aid eligibility than they did in the past.

Financial aid eligibility is calculated by subtracting a student’s expected family contribution from the school’s cost of attendance. Since a student is usually required to contribute up to 20% of their assets, parents are required to contribute less than 6% — meaning students can get significantly more aid because of this change.

How Are They Taxed?

Earnings of both types of 529 plans are tax-free. In 30 states, your contributions are deductible for state taxes, as well.

Your withdrawals will be exempt from federal tax and, in many cases, state tax. But if your withdrawals are made outside of the qualifying list of expenses (wait just a tick), you will be subject to federal income tax and a 10% penalty.

In the event that the beneficiary receives a scholarship, attends a U.S. military academy or dies, you can withdraw funds without paying the 10% federal penalty, although you will have to pay income tax on the withdrawal.

What Expenses Does a 529 Plan Cover?

Qualified expenses, i.e., the ones you can use 529 plan funds for without penalty, include:

  • Tuition.
  • Room and board.
  • Technological items used by the beneficiary while enrolled in college.
  • Books and supplies required for school.

Some expenses that are not qualified for withdrawals:

  • Travel to or from school.
  • Student loan payments.
  • Cell phone plans.
  • Health insurance.
A college student looks for a book.
Getty Images

Generally, the amount of tax-free withdrawals you qualify for will depend on how many expenses you accrue. Each year, you will report your 529 contributions and withdrawals to the IRS.

If your withdrawals exceed your qualified higher education expenses for the year, you will pay taxes on the amount you withdraw over the qualified expenses. In some states, you could face an additional penalty.

It’s also worth noting that the $10,000-per-year-per-beneficiary allowance we discussed earlier for K-12 education can only be used to cover tuition — not any supplies or other education-related expenses.

How Does Money Grow in a 529?

Since a 529 plan is an investment vehicle and not an investment, you’ll need to decide where to put the money within the account. (This does not apply to prepaid tuition 529s.)

The most common options for investment are exchange-traded funds, target-date funds and mutual funds, according to Isaac Valley, a financial adviser in Bradenton, Florida.

Exchange-traded funds (ETFs) and mutual funds are both collections of securities that are designed to track the performance of indexes like the S&P 500 or the Dow. Both of these investments options are considered static, meaning that your investments will not change year to year unless you elect to redirect your funds — which you can do twice per year.

For the average investor, though, Valley’s suggests target-date funds. The set-it-and-forget-it nature of this option is a plus for many. You buy into a fund based on the year you will begin to take withdrawals, and the investments will automatically be set and readjusted in the years leading up to that date.

“When you start out, that target-date fund is going to have more of its allocations put into growth markets,” says Valley. “Of course, there’s more risk involved in the short term, but long term, [there’s] better potential for gain. And then as you get closer to the end, it becomes more balanced, more allocated into fixed income — it’s steadier, less risk.”

You can also elect to open a direct-sold 529, meaning you won’t have a financial adviser. Of course, this means you’ll save on fees — typically around 1%.

This option will also allow you to choose between a static investment approach — typically selected based on your risk tolerance — and an age-based fund.

How Do You Withdraw Money From a 529?

College students walk to class.
Getty Images

When it’s time to withdraw the funds, you can have the money sent to the account’s owner, the beneficiary or directly to the school.

If you decide to send the payments to yourself — which can include having funds sent to your bank or a brokerage account — you should also know that you’ll need to submit the request within the same calendar year that you paid the expense.

You can also have the money distributed to the beneficiary. If the beneficiary does end up needing to use the funds for an unqualified expense, they will still be required to pay income tax, but they will almost surely be in a lower tax bracket than the account’s owner.

What Happens to Unused Funds in a 529?

You might wonder if 529 plans are too limited to make sense. After all, what happens when your child gets that full-ride scholarship? Or what if they don’t go to college?

In short, though, if you have multiple children who you expect to go through college, a 529 plan will make a lot of sense — even if not all of your children use the funds you expect.

That’s because you can change the beneficiary of the account to another family member of the original beneficiary. Once every 12 months, you can also roll over unused funds to a family member’s 529.

If you don’t have multiple children you’re saving for, your options will be to transfer the funds to a family member of the child or simply eat the 10% penalty and make an unqualified withdrawal. But remember, if the student receives a scholarship, you may only have to pay income tax on withdrawals from the account.

529 Plan Pros and Cons

Like any investment option, 529 plans have certain advantages and disadvantages. Here are a few 529 plan pros and cons:


  • You can lock in current tuition costs if you choose a prepaid plan.
  • There are no income or contribution limits that restrict your ability to save.
  • Your money grows tax-free.
  • Anyone can contribute to the plan.
  • Money in 529s affect a child’s financial aid eligibility less than other assets owned by their parent(s).
  • Qualified withdrawals are not taxed.
  • If your child receives a scholarship or attends a military academy, the money becomes available without the 10% penalty.
  • Unused funds can be transferred to family members tax-free.


  • Prepaid tuition plans may charge a fee for withdrawals to cover out-of-state expenses.
  • You’ll pay tax on any unused funds that you transfer to a retirement account.
  • There’s a $10,000 withdrawal limit per year for K-12 private school tuition.
  • There can only be one beneficiary, so you’ll have to open a separate account for each child.

You’ll notice the cons have more to do with convenience and high dollar problems than the practical logistics that most of us will face.

But those special circumstances and preferences could be the difference for some.

Let us try to paint such pictures.

Suppose you’ve only got one kid. You’re saving for college, but you have less than $6,000 per year to put in that direction. You’re funding your 401(k) sufficiently, so you don’t need additional investment vehicles for your own retirement.

If this is you, then it might make just as much sense to use your Roth IRA to save for your child’s college. With a 529, you contribute after-tax money; the same goes for a Roth IRA.

Your 529 withdrawals on qualified education expenses are tax-free. For a Roth IRA, you can withdraw contributions tax-free; you’ll only pay income tax for education-related withdrawals from the account’s earnings.

If you save more than you need? With a Roth IRA, you simply keep the funds — no 10% penalty unless you withdraw from the account’s earnings before the age of 59 ½.

Or if you’re truly uncertain about how you’ll use the money, you could just open a taxable account and focus on saving as much money as possible.

The point is, 529 plans are made to save for college. So if you’re saving for college, they’re tough to beat. But you may not be the run-of-the-mill investor. There could be other options that make more sense for you.

Which is why you should really take this information and go speak with a professional before you open a 529 plan.

Jake Bateman is a writer and editor in Florida.