What Is a 529 College Savings Plan? Benefits and Alternatives

A 529 college savings plan gives you a tax break as you save for not just college, but even for K-12 tuition costs. While 529 plans have tax advantages and other benefits, there are also some downsides, like limited investment choices.

How does a 529 college savings plan work?

A 529 savings plan is a tax-advantaged account designed to help people save for education expenses.

529 plans are usually state-sponsored programs, but you don’t need to choose the 529 plan in your home state. Then again, some state programs have special tax benefits for residents.

With 529 savings plans, you can only have one beneficiary at a time, but you’re allowed to swap one beneficiary for another person in the same family, such as a sibling.

Contributions

Although 529 plans don’t have annual contribution limits, each state sets a lifetime contribution cap.

Money you contribute to a 529 plan is considered a gift by the IRS, but you can give a certain amount each year without triggering gift taxes.

In 2024, you can contribute up to $18,000 per recipient ($36,000 if married filing jointly) without paying gift taxes. So a single parent with two kids could contribute $18,000 per child without having to pay gift taxes and without it counting towards their lifetime gift tax exemption.

Withdrawals

You can withdraw as much as you want from a 529 for educational expenses, with two exceptions:

• K-12 tuition expenses: You can only use up to $10,000 a year per child to pay for K-12 tuition.
• Student loans: You can only use 529 funds to repay student loans up to a lifetime limit of $10,000 per person.

If you use 529 savings account money for something other than a qualified education expense, you’ll have to pay federal income taxes on it, along with a 10% penalty and possibly state or local taxes.

If you accidentally withdraw too much from a 529, you have 60 days to return the money to a 529 account for the same beneficiary if you want to avoid taxes and penalties.

Tax advantages

One of the most popular features of 529 savings plans are their tax benefits. You pay zero federal income taxes on the money you withdraw from a 529, so long as it’s for qualified educational expenses.

Investment earnings are also not subject to federal taxes when used to pay for education expenses.

Fees

529 savings plans charge various fees, including:

• Enrollment fee: This is more common enrolling in an out-of-state 529 program. If you choose a 529 plan in your state, the provider may waive the enrollment fee.
• Annual maintenance fee: Some 529 plans charge an annual maintenance fee, which can range from $10 to $50.
• Administrative fee: You’ll also want to be on the lookout for any administrative or operating fees — which are usually charged as a percentage of your 529 account balance.
• Underlying investment fees: When you contribute to a 529, the money goes into an underlying investment, such as a mutual fund or index fund, which may charge additional fees.

Pros and cons of 529 plans

Types of 529 plans

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

529 savings plan

This is the traditional 529 plan which we’ve been discussing. You can save for any college, elementary or secondary school without getting taxed on your investment returns or withdrawals.

Prepaid tuition plan

A prepaid tuition plan lets you save for tuition at a specific college. Not every state offers prepaid tuition plans, and you or the beneficiary may need to be a resident of the state offering the plan to qualify.

The main benefit of this type of plan is you can pay for future tuition in current dollars and prices. So if the price of tuition goes up, you’re already locked in to the earlier, lower price. You can often choose how you pay, such as:

• In a lump sum, upfront payment
• With a five-year payment plan
• In fixed monthly installments

How to open a 529 college savings plan

Here are the steps to opening a 529 plan:

1. Choose your plan: Check if your state offers a 529 program, along with any incentives for residents. Compare 529 plans from multiple providers to find the best option for your needs, checking for fees and investment options.
2. Select a beneficiary: Name the person you want the money to go to (the beneficiary), which could be your child, grandchild, yourself or any other person whose educational journey you want to support. You can change to another beneficiary without penalty, so long as they are members of the same family.
3. Open the account and invest: You can usually open a 529 through your state plan’s website or with a brokerage firm. You should have basic info available for you and your beneficiary, such as Social Security numbers, birthdates and addresses.

529 savings plan alternatives

A 529 college savings plan isn’t the only choice you have. Other ways to save for school include:

• Coverdell education savings account: Like 529 plans, Coverdell accounts have tax-free withdrawals for tuition, room and board, books and other school costs. But a big difference is that Coverdell accounts have an income limit for contributions, while 529 plans don’t. Also, you can only contribute $2,000 a year to a Coverdell account.
• Savings account: You can use a traditional or high-yield savings account for education expenses if you want total freedom on how you spend the money. Of course, you won’t get the tax advantages of a 529 plan.
• Brokerage account: A regular brokerage account doesn’t come with tax benefits, but you will have access to whichever investment options you want, as well as no limits on what you use the money for.
• Roth IRA: You can use your Roth IRA to pay for most educational costs without suffering a penalty. Keep in mind, though, spending money from your Roth IRA could derail your retirement plans.

Frequently asked questions

Is a 529 college savings plan worth it?

529 college plans are one of the best tools available to save for education expenses. Many consider 529s to be worth it for their tax benefits alone: the earnings in a 529 are tax-free if you use them for qualified education expenses.

What happens to 529 money if you don’t spend it?

If there is money left over in the 529 plan, you have a few options:

• Change the beneficiary to a qualified family member or yourself
• Roll the money into a Roth IRA for the beneficiary
• Pay up to $10,000 toward the student loans of the beneficiary (or their siblings)
• Withdraw the money to use for other purposes, even though you’ll face a 10% penalty and income taxes on the funds.

What’s the difference between a 529 plan and a brokerage account?

There are two main differences between 529 plans and brokerage accounts:

• 529 plans are specifically for education expenses, while brokerage accounts for general investment.
• 529 plans have special tax benefits if you use them for education, while brokerage accounts don’t.