It’s no secret that college is expensive. Over the past 20 years, the cost of attending a public 4-year educational institution increased by 141%. In parallel, student loan debt has risen to nearly $1.6 trillion as of 2024, an increase of about 42% compared to 2014. While some parents and students start saving for college early on, at least 30% of adults seeking post-high school education still took out some form of student loans last year.

Considering the rise in higher-education costs, families need to be prepared. Undergraduate loans can help pay for college, but the more you save now, the less you or your student owes later. Opening a simple savings account can work, but it won’t maximize your funds over time. This is why many parents choose to save in a 529 college savings plan. 

If you’re wondering, “what is a 529 plan, and how does it work?”, you’re not alone. Studies have shown that only about half of Americans know what a 529 plan is—and even fewer invest in them. 

This article will explore the various types of 529 plans and their advantages for parents or guardians looking to build up savings for their students’ future college expenses.

Key Takeaways

• A 529 plan is a tax-advantaged savings account used to cover future education costs like tuition, books, and housing. Earnings grow tax-deferred, and withdrawals for qualified expenses are tax-free.
• There are two types of 529 plans: prepaid tuition plans, which lock in current tuition rates but only apply to specific schools, and education savings plans, which offer broader use but are tied to market performance.
• Opening a 529 involves choosing a plan, naming a beneficiary (which you can change at any time), and funding the account. Many plans are accessible online and allow contributions from family and friends.
• If unused, funds can be rolled into a Roth IRA, transferred to another beneficiary, or withdrawn with taxes and penalties.

What Is a 529 Plan?

A 529 college savings plan is a tax-advantaged way for families to save for future education costs, including 4-year colleges, trade schools, graduate schools, or apprenticeships. A 529 plan can be sponsored by a state or state agency, or an educational institution.

You can find a list of all the 529 plans offered by state here.

Types of 529 Plans: How Do They Work?

529 plans vary in how they work depending on the type of plan. According to the U.S. Securities and Exchange Commission, there are two types of 529 plans–prepaid tuition plans and education savings plans.

Prepaid Tuition Plans

With prepaid tuition plans, families can purchase credits or units at specific colleges and universities to cover tuition costs or fees, minus room and board. Prepaid tuition plans are controlled by the donor, who is often the parent or guardian, and sponsored by state governments, not the federal government. Each state may have requirements for the school you select. 

There are some pros and cons of a 529 prepaid plan. Pros include tax-free withdrawals and locking in tuition costs at the current rate, which is great for students who won’t attend college for several years. Some potential drawbacks include:

• Only valid for certain institutions
• They don’t cover room and board 
• Not guaranteed by the federal government

Education Savings Plans

Education savings plans are the most common type of 529 because they can be used at any eligible college or university, including non-U.S. institutions. Families can open an investment account to pay for future education costs like tuition, fees, and room and board, unlike prepaid tuition plans.

The primary benefit of a 529 plan that isn’t prepaid is its flexibility and tax advantages. It can be used at more institutions and for more education-related expenses. However, you cannot lock in tuition rates and are subject to market fluctuations.

How to Open a 529 Plan

Now that you know more about what a 529 plan is and how it works, opening one can be done in a few easy steps: 

1. Choose Your Plan

Before opening a 529 plan, shop around to find the best plan for your needs. It may be best to choose a 529 plan sponsored by your state because they offer state income tax deductions on contributions. However, you can choose plans from other states too.

Weigh the pros and cons of the 529 plan you’re considering, such as:

• Fees associated with managing the plan
• The types of investments available (conservative vs. aggressive approach)
• Contribution limits
• Penalties and restrictions, like whether you can change the beneficiary
• Who controls the account

2. Open Your Account and Choose a Beneficiary

After choosing your 529 and identifying the beneficiary, you can fill out the application (typically online) with the following information: 

• Personal information, such as your name, date of birth, Social Security number, and address
• Beneficiary details, such as their date of birth and Social Security number

Usually, a beneficiary is your child, but it can be your grandchild or another student in your life. In fact, you can name anyone you want as a beneficiary as long as they are a U.S. citizen and have a Social Security number.

3. Make Your Contributions

Anyone can make contributions to a 529, including family members and friends. Contributions can’t exceed what’s necessary for eligible education costs, and there may be gift tax penalties if contributions exceed a certain amount in the year. IRS Form 709 can help you determine tax implications on gift taxes related to 529 plans. You should also check your state’s yearly tax deduction limits and lifetime contribution limits, as each state sets its own rules. 

Contributions can be made by check, electronic transfer, or payroll deduction.

4. Direct Your 529 Investments

One of the benefits of 529 plans is choosing how you want to invest and manage the account. Some 529s have investment options that include mutual funds, which pool money from different investors. 

You can choose to manage your investments or have a money manager do it for you. If you’re unfamiliar with investing, a money manager can help you choose a suitable 529 investment strategy and allocate funds to meet your financial goals. 

Using Funds from 529 Plans

Most 529 plans have an online withdrawal option to access funds. You may also be able to electronically receive or send funds directly to the beneficiary or educational institution. 

529 plans only work for qualified expenses, so check your plan terms before using the funds. Qualified expenses can be withdrawn tax-free, but unqualified expenses may incur a penalty.

Qualified expenses can include:

• Tuition
• Books
• School-related supplies
• Room and board (if it’s not a pre-paid 529 plan)

Non-qualified expenses can include:

• Transportation
• Cell phone bills
• Clothing
• Recreational activities

If you’re unsure how 529 plan withdrawals may affect your taxes, a tax professional can help you understand any potential tax implications or penalties. 

Primary Benefits of 529 Plans

For families who want to save for college, there are several advantages of 529 plans:

• Contributions can qualify for a gift tax exclusion.
• Your earnings grow tax-deferred.
• You can roll over unused money into a Roth IRA under the name of the plan’s beneficiary. 
• Most states allow you to take a state tax deduction for a 529 plan. 
• Enjoy tax-free withdrawals on qualified education expenses.
• Funds are transferable to another child if the beneficiary doesn’t use them. 

Potential Drawbacks of 529 Plans

Overall, a 529 college savings plan is a good idea if you want to start saving for your child’s education. There are, however, some disadvantages to consider before opening a 529 plan:

• Could limit financial aid. 529 plans are considered parent assets on the FAFSA, which can reduce a student’s financial aid package, although usually not by much.   
• Less control over investment options: Since 529 plans are administered by the state you live in, you’re limited to the investment options provided by your state. In some cases, you may yield a higher return on investments like individual stocks. 
• Taxes or penalties for non-school-related withdrawals: Non-qualified withdrawals are subject to being taxed. If 529 plan rules aren’t followed, you may also incur penalties.
• Fees: If you hire a money manager to help manage your 529 plan, you may pay higher fees. Certain investment options also have fees, so make sure you understand the terms before opening a 529 plan.

As with most investments, there is some risk involved, but the benefits of 529 plans often outweigh the risks.

Are 529 Plans Worth It?

If you plan to save for your student’s education, opening a 529 plan is an option worth exploring. The tax savings can add up fast, and having a dedicated 529 plan can help ensure your savings go toward your student’s education. Before opening a 529, you should understand the plan’s details and ensure that saving this money and making regular contributions will not put you in financial hardship. 

Learn More With Ascent

In addition to a 529 plan, there are multiple ways you and your child can help pay for school, including scholarships and federal financial aid. If any gaps in expenses remain, you can also consider private student college loans, including loans with cosigners and student loans without a cosigner. 

Ascent is committed to providing resources for students and families in college—and beyond. Whether your student is about to graduate or you are planning your savings years ahead of time, check out our website for more financial wellness resources and tips on how to pay for college. 

FAQs

Is there an age limit on a 529 plan?

There is no age limit on 529 plans. Any U.S. citizen or resident with a tax ID or social security number can be a beneficiary, regardless of their age. 

Do you need to open a 529 plan for each child?

You can only have one beneficiary named to a 529 plan which is the child who will use the plan for education expenses. However, if your children aren’t attending college simultaneously, you can transfer the 529 plan from student to student when the time comes.

If your children will be attending school at the same time, they cannot both pull money from the fund. If your children are close in age, you may want to create separate 529 plans for each of them. 

Who can contribute to a 529 plan?

While there is only one account holder on a 529 plan, anybody can contribute! Grandparents, aunts, uncles, or friends can invest in your student’s future by contributing to the 529 plan. Be sure to recommend it as a gift option during birthdays, holidays, graduations, and other special occasions.

Is it better for a parent or grandparent to own a 529 plan?

Grandparents can open 529 plans for their grandchildren. However, that money will count as untaxed income for the student, and may affect federal financial aid. It’s preferable for parents to own 529 plans.

What can 529 plan funds be used for?

You can use 529 plan funds for most education-related expenses, depending on the type of 529 plan you have. These include tuition, books, school supplies, and room and board. You can also use it toward student loan repayment up to a certain amount. 

What happens to a 529 savings plan if the child doesn’t go to college?

If your child doesn’t attend college or graduate school, you can withdraw the money or use the funds to pay for other expenses but you will be subject to federal income taxes and a penalty on the earnings. You can also choose to roll over unused funds into a Roth IRA for the beneficiary.

What are the tax advantages of a 529 plan?

There are great tax advantages to 529 plans, like tax-deferred earnings and tax-free withdrawals when funds are used for qualified education expenses. Many states also offer state tax deductions when you contribute to 529 plans. 

Can a 529 plan impact financial aid eligibility?

There may be minimal impact to financial aid eligibility since 529 plans are considered a parent asset. Overall, the benefits of a 529 plan outweigh the impact on FAFSA.