Can You Use a 529 Certificate of Deposit for Education Savings?

Saving for education can be done in several ways, and 529 plans are among the most popular options due to their tax advantages. Within a 529 plan, different investment choices exist, including certificates of deposit (CDs), which offer a lower-risk option compared to stocks or mutual funds.

Understanding how CDs work within a 529 plan is important before committing to this approach. Factors like deposit requirements, maturity terms, and withdrawal rules affect whether it’s a suitable choice for your savings strategy.

Opening a CD in a 529

Some 529 plans offer CDs as an investment option, allowing account holders to benefit from FDIC or NCUA insurance while earning a fixed interest rate. These CDs must be selected through the plan provider rather than opened separately at a bank. Availability varies by state, as not all 529 plans include CDs.

Unlike market-based investments, CDs provide a predictable return, making them appealing for those who want to avoid volatility. However, interest rates depend on broader economic conditions, and in a low-rate environment, returns may not keep pace with tuition inflation. Some plans offer step-up CDs, where the rate increases over time, or indexed CDs, which adjust based on external benchmarks.

Liquidity is another factor. Since 529 plans are designed for long-term education savings, CDs within these accounts may have restrictions on early withdrawals. Some plans allow funds to be moved into other investment options within the 529, but this is subject to plan rules and potential penalties.

Minimum Deposit and Maturity Terms

The minimum deposit required to open a CD within a 529 plan varies by provider. Some plans allow contributions as low as $250, while others require $1,000 or more. Unlike traditional bank CDs, which sometimes offer promotional rates for higher deposits, 529 plan CDs typically follow standardized terms set by the plan administrator.

Maturity terms often align with education savings timelines, offering options like one, three, or five years. Choosing the right maturity length is important because funds locked in a long-term CD may not be available when tuition payments are due. Some plans offer automatic reinvestment at maturity, rolling the balance into a new CD unless the account holder selects a different investment.

Interest rates are tied to the maturity period, with longer-term CDs typically offering higher rates. However, locking in a rate for several years carries the risk of missing out on potential rate increases. In a rising interest rate environment, shorter-term CDs may provide more flexibility to reinvest at higher yields later. Some 529 plans offer laddering strategies, allowing savers to stagger maturity dates to balance liquidity and returns.

Qualified Educational Expenses

Funds from a 529 plan, including those held in CDs, must be used for qualified educational expenses to maintain their tax-free withdrawal status. These expenses include tuition, fees, books, supplies, and equipment required for enrollment at an eligible institution. Computers and internet access also qualify if necessary for coursework.

Room and board expenses are eligible for students enrolled at least half-time. The maximum allowable amount is determined by the institution’s published cost of attendance or the actual amount paid, whichever is lower. Off-campus housing qualifies, but expenses must not exceed the school’s stated room and board allowance. Families should keep documentation, such as rental agreements and utility bills, to substantiate claims if needed.

K-12 tuition expenses up to $10,000 per year per beneficiary are also covered under 529 rules. However, this applies only to primary and secondary school tuition, not other costs like books or extracurricular fees. Additionally, up to $10,000 in lifetime student loan repayments per beneficiary—and their siblings—can be paid using 529 funds, providing some relief for graduates managing education debt.

Early Withdrawal and Penalties

Withdrawing funds from a 529 plan before they are needed for education can lead to financial consequences. When a CD within a 529 is withdrawn before its maturity, the account holder typically faces two types of penalties: those imposed by the financial institution on the CD itself and those enforced by the IRS for nonqualified withdrawals. Banks or credit unions generally charge an early withdrawal penalty, which can range from a few months’ worth of interest to the full amount earned.

Beyond the financial institution’s penalties, the IRS imposes a 10% penalty on the earnings portion of any 529 withdrawal not used for qualified educational expenses. This penalty is in addition to federal and state income taxes owed on the withdrawn earnings. Some states also impose recapture taxes, requiring account holders to pay back any state tax deductions or credits previously claimed. These additional costs make early withdrawals particularly expensive in states with high income tax rates or generous 529 tax incentives.

Rolling Over or Redeeming the CD

When a CD within a 529 plan reaches maturity, account holders must decide whether to roll over the funds into another investment or redeem them for educational expenses. The decision depends on the timing of tuition payments and the overall investment strategy within the 529 plan. Some plans offer automatic reinvestment into a new CD with a similar term, while others require manual selection of a new investment option. If tuition payments are approaching, redeeming the CD and transferring the funds to a checking or savings account linked to the 529 plan may be the most practical choice.

Rolling over a maturing CD into another 529 investment can provide continued tax-deferred growth, but it must be done within the same plan or transferred to another state’s 529 without triggering tax penalties. IRS rules allow one tax-free rollover per beneficiary every 12 months, meaning frequent changes could result in unintended tax consequences. If the funds are no longer needed for education, they can be transferred to a different beneficiary within the same family, such as a sibling or even a parent returning to school. This flexibility helps prevent unnecessary withdrawals that could lead to penalties and taxes.

Tax Implications

The tax benefits of 529 plans make them a popular education savings tool, but understanding the tax treatment of CDs within these accounts is important for maximizing savings. Earnings on CDs grow tax-deferred, meaning no federal or state taxes are owed as long as the funds remain in the account. When withdrawals are used for qualified educational expenses, both the principal and interest can be taken out tax-free.

For nonqualified withdrawals, only the earnings portion is subject to federal income tax and a 10% penalty. Some states also impose additional taxes or require repayment of previously claimed deductions. However, exceptions exist for cases such as the beneficiary receiving a scholarship, attending a U.S. military academy, or becoming disabled. In these situations, the 10% penalty is waived, though income taxes on earnings still apply. Proper planning and documentation can help account holders avoid unexpected tax liabilities while ensuring funds are used efficiently.