How Do 529 Plans Work? Rules for Contributions & Withdrawals

A 529 plan is a tax-advantaged savings vehicle designed to encourage saving for future education costs. Named after Section 529 of the Internal Revenue Code, these plans are sponsored by individual states and allow individuals to contribute money that can then be invested. The primary benefit is that investment earnings accumulate on a tax-deferred basis, and withdrawals for qualified education expenses are entirely free from federal income tax.

Key Decisions Before Opening an Account

Before opening a 529 plan, you must first decide between the two primary types: education savings plans and prepaid tuition plans. Education savings plans function much like a Roth IRA, where your contributions are invested in portfolios composed of mutual funds or exchange-traded funds (ETFs). The account’s value will fluctuate based on the performance of these investments, offering the potential for growth but also carrying market risk.

Prepaid tuition plans allow you to purchase tuition credits at today’s prices for future use at eligible in-state public colleges. These plans do not cover expenses like room and board and may have limitations on which institutions they can be used for. The money contributed to a prepaid plan is not guaranteed by the federal government, so understanding the specific state’s guarantee is important.

Another choice is which state’s plan to use, as you are not restricted to your home state. The primary incentive for using your own state’s plan is the potential for a state income tax deduction or credit on contributions, though not all states offer this. An out-of-state plan might be advantageous if it offers lower fees or more appealing investment options.

Finally, you must identify the account owner and the beneficiary. The account owner is the individual who opens and manages the account, controlling all investment decisions and withdrawals. The owner also retains the right to change the beneficiary to another qualifying family member at any time. The beneficiary is the student for whom the savings are intended, and the account owner and beneficiary can be the same person.

Funding and Growing Your 529 Plan

While there are no federal annual contribution limits for 529 plans, contributions are treated as completed gifts for federal gift tax purposes. For 2025, an individual can contribute up to $19,000 per beneficiary without incurring gift tax. This allows a married couple to jointly contribute up to $38,000 per year for each beneficiary.

A unique feature of 529 plans is the ability to “superfund” an account, which allows a contributor to make a lump-sum contribution equivalent to five years of the annual gift tax exclusion at one time. This means an individual could contribute up to $95,000, and a couple up to $190,000, in a single year without triggering the gift tax, provided no other gifts are made to that beneficiary during the five-year period. Each state also sets its own aggregate contribution limit, which is the total amount that can be saved for one beneficiary.

Within an education savings plan, you will find several investment options. Many plans offer age-based or target-date portfolios, which automatically shift their asset allocation from more aggressive to more conservative investments as the beneficiary nears college age. Some plans also provide static portfolios where you can select a specific mix of stock and bond funds. Contributions must be made in cash, so assets like stocks or bonds must be liquidated before being put into the plan.

Using Your 529 Plan Funds

Funds can be withdrawn tax-free for qualified higher education expenses (QHEEs) at an eligible postsecondary institution. These expenses include:

• Tuition and fees
• Books, supplies, and equipment required for enrollment
• Computers, peripheral equipment, software, and internet access
• Room and board, if the student is enrolled at least half-time

The use of 529 funds has expanded beyond traditional college costs. You can withdraw up to $10,000 per beneficiary per year, tax-free, to pay for tuition at an eligible elementary or secondary school. Funds can also be used for expenses related to registered apprenticeship programs, and a lifetime limit of $10,000 per beneficiary can be used to repay qualified student loans.

Tax-free rollovers from a 529 plan to a Roth IRA for the beneficiary are also permitted under certain conditions. The 529 account must have been open for at least 15 years, and the funds being rolled over must have been in the account for more than five years. The amount rolled over in a given year cannot exceed the annual IRA contribution limit for that year, which for 2025 is $7,000, and is subject to a lifetime maximum of $35,000 per beneficiary.

To pay for expenses, you can have the funds paid directly to the educational institution or have the distribution sent to the account owner or beneficiary for reimbursement. If you use the reimbursement method, keep detailed records, such as receipts, to prove the funds were used for qualified expenses. The plan administrator will issue a Form 1099-Q to the recipient of the distribution.

Rules for Non-Qualified Withdrawals

A non-qualified withdrawal is any distribution from a 529 plan not used for approved education expenses, such as personal expenses, transportation, or health insurance. When you take a non-qualified distribution, the withdrawal is separated into two parts: your contributions and the earnings.

The portion of the withdrawal representing your original contributions is returned free of federal tax and penalty. The earnings portion, however, is subject to both ordinary income tax and an additional 10% federal penalty tax. Many states also impose their own income tax and potentially a penalty on the earnings.

The 10% federal penalty on non-qualified withdrawals is waived in specific circumstances, although the earnings are still subject to ordinary income tax. These exceptions include:

• The death or permanent disability of the beneficiary
• The beneficiary receives a tax-free scholarship, but only up to the amount of the award
• The beneficiary receives veteran’s educational assistance
• The beneficiary receives employer-provided educational assistance
• The beneficiary attends a U.S. military academy