What Is a 529 Plan?

What Is a 529 Plan?

A 529 plan is a tax-advantaged investment account that helps families save for college, postgraduate education, K-12 private school tuition and qualifying apprenticeship and credentialing programs.

Most 529 plans are sponsored by states (and some by groups of schools). Contributions to a 529 plan grow tax-deferred, and withdrawals used to pay for qualifying expenses are tax-free. In addition, many states offer tax credits or tax deductions for 529 contributions.

How Does a 529 Plan Work?

A 529 plan is typically opened by a parent or grandparent, the account owner, for a designated beneficiary, such as a child or grandchild. The account owner controls the funds, even after the beneficiary turns 18, and can change the beneficiary to another eligible family member if plans change.

Once contributed, 529 funds are invested in portfolios offered by the plan. Many plans provide age-based investment options that start more aggressively and become more conservative as the beneficiary approaches college age. There are also static investment portfolios that maintain a consistent investment mix unless you adjust them.

When it's time to use the funds, withdrawals are tax-free if used for qualified education expenses, including tuition, required fees, room and board, books and other costs detailed below.

Withdrawals for nonqualified purposes are subject to federal taxes and a 10% penalty fee on the earnings portion of the withdrawal.

Types of 529 Plans

There are two kinds of 529 plans: education savings plans (or college savings plans) and prepaid tuition plans.

Education Savings Plans

An education savings plan is the most common type of 529 plan and the most flexible option if you're not sure where your child will attend college. Contributions can be used for qualified education expenses at eligible schools. (See the list of qualified expenses below.)

Prepaid Tuition Plans

Prepaid tuition plans let you lock in tuition at current rates by purchasing tuition credits for participating in-state public colleges. They're typically state-sponsored and limited to state residents. Funds generally cover only tuition and fees, and can't be used for K-12 tuition, apprenticeships or student loans.

Learn more: Should I Save for Retirement or for My Kids' College?

529 Plan Contribution Limits

You and your spouse can each contribute $19,000 per year to your child's 529 plan. Contributions above this amount must be reported to the IRS and count against your lifetime gift tax exemption.

There are no annual federal contribution limits on 529 plans, but states set their own limits on the aggregate amount that can be contributed to one beneficiary's 529 accounts. Generally, this lifetime cap ranges from $235,000 to $550,000 or more.

Learn more: How Much Should You Save for Your Child's College?

What Qualifies as an Expense for a 529 Plan?

To get the most from a 529 savings plan, it's important to understand what is considered a qualified expense.

Qualified Expenses

• Required tuition and fees for eligible college, graduate school, nondegree and credentialing programs as approved by the U.S. Department of Education
• Required tuition and fees for eligible apprenticeship programs
• Room and board (for students attending at least half time)
• Required books, instructional materials and supplies
• Required computers, peripheral equipment, software and internet access
• Fees for standardized testing
• Cost of educational therapy for students with disabilities or special needs
• Up to $20,000 per year for K-12 tuition, fees and qualified expenses above
• Up to $10,000 per lifetime for repaying student loans for the beneficiary or a sibling

Nonqualified Expenses

• Transportation or travel to and from school
• Activity fees not required for enrollment
• Medical or health insurance expenses
• Personal electronics or technology

Tip: For each category, you can't withdraw more than the school's estimated cost for that category in that school year. (You can generally find this information on the school's website.)

Pros and Cons of 529 Plans

Before opening a 529 plan, you should be aware of their advantages and disadvantages.

Learn more: Qualifying for Student Loans: What You Need to Know

Is a 529 Plan Worth It?

A 529 plan may be worth opening if:

• You want a tax-advantaged way to save for K-12 or college tuition
• You feel confident the funds will be used for qualified education expenses
• You want to keep control of the funds

A 529 plan may not be a good fit for your family if:

• You aren't confident your child will want to attend college or vocational school
• You're prioritizing other financial goals such as saving for retirement or buying a home

Learn more: Best Ways to Save for College

How to Open a 529 Plan

To open a 529 plan, follow these steps:

1. Choose a plan. First, decide if you want a prepaid tuition plan or an education savings plan. The National Association of State Treasurers' College Savings Plan Network has links to most 529 plan websites. When comparing plans, evaluate state tax benefits, plan fees and investment options.
2. Apply for an account. You'll need names, contact information, birth dates and Social Security or Individual Taxpayer Identification numbers for both the account owner and the beneficiary.
3. Fund the account. You can typically fund a 529 plan using checks or electronic transfers from a bank account. Consider setting up automatic contributions.
4. Pick your investments. Choose the investment portfolio that fits your savings goals and risk tolerance.

Tip: Once a 529 plan is set up, let grandparents and other family members know about the account; they can chip in too.

Frequently Asked Questions

The Bottom Line

A 529 plan can be an advantageous way to save for college, but your student may need other financial help to cover all the costs. Your credit history and credit score may be a factor for some types of student loans, such as private loans. You can check your FICO^® Score^Θ from Experian for free to see where you stand and what you can do to help improve your credit.