What Is a 529 Plan?

Quick Answer

A 529 savings plan allows families to save for college, graduate school, apprenticeships and even K-12 tuition while enjoying tax advantages.

College students hanging out in a group around a table.

Knowledge may be priceless, but a college diploma gets pricier every year. The average annual tuition and fees for in-state students at a public four-year college for the 2022-2023 school year is $10,950 (or $43,800 for four years), according to the College Board. For a private four-year college, average annual tuition and fees hit $39,400 per year (or $157,600 for four years). If you'd like to establish a college fund for children and grandchildren, consider a 529 plan. A 529 plan is a tax-advantaged investing account used to save for college, post-graduate education or even K-12 tuition.

What Is a 529 Savings Plan?

A 529 plan helps families save for college, postgraduate education or K-12 private school tuition. The federal SECURE Act of 2019 expanded eligible uses of 529 plans to cover certain apprenticeship programs and allowed them to be used to repay a limited amount of student loans.

Some 529 plans are offered by states, others by groups of participating schools. Typically, the person who starts the 529 savings plan (the account owner or plan owner) establishes the plan for a chosen beneficiary (such as a child or grandchild). The plan's owner controls the money in the plan, even after the beneficiary turns 18. If the beneficiary doesn't attend college, the account holder can transfer the plan to someone else.

Types of 529 Plans

There are two kinds of 529 plans. An education savings plan, the most flexible type of plan, is used to save for tuition and related education expenses at any qualified college or university, sometimes including foreign schools.

  • Money can be used for undergraduate or postgraduate education such as getting a Ph.D. or MBA, or for qualifying apprenticeship programs.
  • Up to $10,000 annually can also be used to pay tuition for K-12 schools, and a total of $10,000 per student can be used to repay student loans.
  • In addition to tuition and mandatory fees, money in an education savings plan can be used to pay for room and board, as well as books, supplies and equipment required for a program of study.
  • Education savings plans typically offer a range of investment options. They often invest in higher-risk options during the beneficiary's early years and move to lower-risk investments when the beneficiary is 12 or older.

Prepaid tuition plans have more limitations. Prepaid plans let you purchase tuition credits for a specific college or university at today's price and use them in the future, even if the cost of tuition has risen.

  • Prepaid tuition plans generally apply only to public, in-state schools.
  • Money in prepaid tuition plans typically can't be used for room and board.
  • If your child doesn't get into their desired college or decides to go elsewhere, you can usually apply the funds to another participating college or university.
  • Funds from prepaid tuition plans can't pay for elementary or secondary school tuition, apprenticeships or student loans.

How Much Can I Contribute to a 529 Plan?

Although there are no annual contribution limits on 529 plans, states set their own limits on the aggregate amount that can be contributed to one beneficiary's 529 accounts. Generally, this limit ranges from $235,000 to $550,000, and is based on the cost of a high-priced four-year college and graduate school in the state.

If you contribute more than $17,000 in 2023 to the same beneficiary's 529 accounts, you'll need to file IRS Form 709 to report the gift, which counts against your lifetime gift tax exemption (currently $12.92 million). You and your spouse can each contribute $17,000 to your child's 529 plan without paying gift taxes.

What Are Qualified Expenses for a 529 Plan?

Funds from a 529 plan can be withdrawn tax-free for the following qualified expenses:

  1. Required tuition and fees
  2. Room and board (for students attending at least half time)
  3. Books, supplies and equipment
  4. Computer or peripheral equipment (such as a printer), computer software and internet access

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

Funds from 529 plans can also pay for fees, books, equipment and supplies for apprenticeship programs that are registered and certified with the U.S. Department of Labor or a state agency.

Finally, 529 funds can be used to repay up to $10,000 in qualifying student loans for the plan beneficiary or a sibling.

Some education-related expenses aren't qualified expenses—furnishing your child's dorm room or flying her to an out-of-state school, for instance. Using 529 funds for these purposes will trigger federal taxes and a 10% penalty fee on the earnings portion of the withdrawal. (The principal portion of the withdrawal was taxed before it was put into the plan.)

Pros and Cons of 529 Plans

Before opening a 529 plan, understand their advantages and disadvantages.

Advantages of 529 Plans

  • Compound interest: Money invested in a 529 plan benefits from compound interest.
  • Tax benefits: There are no federal income taxes on money withdrawn from the plan for qualified educational expenses. (Some states may tax 529 plan withdrawals.) More than 30 states offer state income tax deductions or tax credits for contributions to 529 plans.
  • Control your contributions: A 529 plan lets you give a child money, but stay in charge of how it's used.
  • Retirement rollovers: Beginning in 2024, up to $35,000 of unused money in a 529 account can be rolled into a Roth IRA.

Disadvantages of 529 Plans

  • Possible tax penalties: If money in a 529 plan is used for anything besides qualified educational expenses, you'll owe taxes on the earnings portion of funds withdrawn, plus a 10% penalty fee.
  • Prepaid tuition risks: If you chose a prepaid tuition plan and your child doesn't go to the college you chose or a participating college, you can still use the money in the prepaid plan for tuition. If the tuition is more than the amount prepaid, however, you'll owe the difference.
  • Investment risk: Depending on how your 529 plan performs and whether it's guaranteed by the state or federal government, you could lose some or all of your investment.
  • Restrictions on usage: A 529 plan limits the amount you can withdraw each year and restricts how the money can be used.

How to Open a 529 Plan

Setting up a 529 plan is simple.

  1. Select a 529 plan. Decide whether you want a prepaid tuition plan or an education savings plan. Look for plans with a track record of good performance and low fees. Financial institutions sell 529 plans through programs in each state; you can typically set up a plan directly through the state program or through a broker.
  2. Complete an application. Provide names, addresses, telephone numbers, email addresses, birth dates and Social Security or Taxpayer Identification numbers for both the account owner and the beneficiary.
  3. Fund the account. You can contribute to a 529 plan using paper checks or electronic transfers from a bank account. Consider setting up automatic contributions. Let grandparents and other family members know about the 529 account, too—they can chip in.
  4. Choose your investments. Select the investment portfolio that fits your savings goals and risk tolerance.

The Bottom Line

Keeping your and your student's credit in good shape can make it easier to cover the costs of higher education. Consider setting up free credit monitoring to help keep an eye on your credit score.