Should I Open a 529 for My Child?
A 529 plan offers a tax-advantaged framework for funding education. Understand its core rules and financial implications to make an informed decision for your family.
The increasing cost of education is a significant financial challenge for many families, with average annual costs ranging from over $29,000 for in-state public universities to more than $62,000 for private institutions. Over the last three decades, these costs have outpaced inflation and wage growth, making it more important for parents to plan and save for the future.
One of the primary tools available is the 529 plan, named after Section 529 of the Internal Revenue Code. This savings vehicle is specifically designed to encourage saving for future education costs. It offers a tax-advantaged way to set aside funds, helping to mitigate the financial strain of paying for a child’s educational journey.
Understanding the Structure of a 529 Plan
A 529 plan involves three key roles. The account owner is the individual who opens and controls the account, with the authority to choose investments, make contributions, request withdrawals, and change the beneficiary. A parent or grandparent often serves as the account owner.
The beneficiary is the future student for whom the money is being saved. While an account can only have one beneficiary at a time, the owner has the flexibility to change the beneficiary to another eligible family member if circumstances change.
A successor owner is an individual designated to take over the account if the owner dies or becomes incapacitated. Designating a successor, who must be at least 18, ensures a seamless transition of control and helps avoid potential delays that could arise from probate court proceedings.
There are two main categories of 529 plans. The most common is the education savings plan, which functions like an investment account where contributions are placed into portfolios that can grow or decrease in value based on market performance. This structure offers the potential for significant growth but also carries investment risk.
The other category is the prepaid tuition plan. These plans allow an account owner to purchase tuition credits at today’s prices for future use at eligible colleges, locking in current tuition rates. Prepaid plans are less common and are sponsored by individual states, often with residency requirements.
Tax and Contribution Rules
A primary appeal of 529 plans is their tax advantages. Over 30 states offer an income tax deduction or credit for contributions made to their specific 529 plan. At the federal level, money invested in a 529 plan grows on a tax-deferred basis. This means the account’s earnings are not subject to annual federal income tax, allowing the balance to compound more rapidly. Withdrawals used for qualified education expenses are also completely free from federal income tax.
Contribution rules are tied to federal gift tax laws. For 2025, an individual can contribute up to $19,000 per beneficiary without needing to file a gift tax return, and a married couple can jointly contribute up to $38,000. Contributions exceeding this annual amount must be reported on an IRS gift tax return and will count against the contributor’s lifetime gift and estate tax exemption.
A unique feature allows for “superfunding,” where a contributor can make a lump-sum contribution of up to five years’ worth of the annual exclusion at one time—$95,000 for an individual or $190,000 for a married couple in 2025. To do this, the contributor must elect to treat the contribution as if it were spread evenly over a five-year period and file a gift tax return. While there are no annual IRS limits on contributions, each state plan has its own aggregate contribution limit, often exceeding $500,000.
Under the FAFSA Simplification Act, a 529 plan owned by a dependent student or a parent is reported as a parental asset on the Free Application for Federal Student Aid (FAFSA). Parental assets are assessed at a maximum rate of 5.64% in the Student Aid Index (SAI) calculation, which minimizes the impact on aid eligibility.
Starting with the 2024–2025 FAFSA, students are no longer required to report cash support from a grandparent-owned 529 plan. As a result, distributions from these plans no longer negatively impact the beneficiary’s eligibility for need-based federal financial aid.
Defining Qualified Education Expenses
To use a 529 plan correctly and avoid penalties, it is important to understand what constitutes a qualified education expense. You should keep detailed records and receipts for all expenditures to substantiate that withdrawals were used for qualified purposes.
The primary use of 529 funds is for qualified higher education expenses at any eligible college, university, or vocational school that can participate in federal student aid programs. These expenses include:
- Tuition and mandatory fees
- Books, supplies, and equipment required for enrollment or attendance
- Technology costs, such as computers, software, and internet access, used primarily by the beneficiary while enrolled
Room and board expenses are also covered if the student is enrolled at least half-time. For students in on-campus housing, the qualified amount is the actual cost charged by the institution. If a student lives off-campus, the amount is limited to the room and board allowance included in the college’s official cost of attendance.
The Tax Cuts and Jobs Act of 2017 allows for distributions of up to $10,000 per beneficiary, per year, to be used for tuition at an elementary or secondary school. This limit is strictly for tuition and does not cover other K-12 school-related costs.
The SECURE Act of 2019 added more flexibility. A lifetime limit of $10,000 per individual can be withdrawn tax-free to pay student loans, a benefit that also extends to the beneficiary’s siblings. The act also made expenses for certain apprenticeship programs a qualified expense, provided the program is registered with the U.S. Secretary of Labor.
Navigating Non-Qualified Withdrawals and Plan Changes
If you use 529 funds for non-qualified expenses, the earnings portion of the withdrawal is subject to ordinary income tax plus a 10% federal penalty. The original contributions are returned tax-free. For example, in an account with $30,000 in contributions and $20,000 in earnings, 40% of any withdrawal is considered earnings. A $10,000 non-qualified withdrawal would mean $4,000 is subject to tax and a $400 penalty.
A key feature of a 529 plan is the ability to change the beneficiary to another eligible family member without tax consequences. The IRS defines a family member broadly, including spouses, children, siblings, parents, and first cousins. This allows funds to be transferred if the original beneficiary receives a scholarship or decides not to pursue higher education.
The SECURE 2.0 Act of 2022 created another option for unused funds. Account owners can now execute a tax-free rollover from a 529 plan to a Roth IRA for the beneficiary. This is subject to several conditions: the 529 account must have been maintained for at least 15 years, and contributions made within the last five years are ineligible. The amount rolled over is subject to annual Roth IRA contribution limits, with a lifetime maximum of $35,000.
How to Select and Open a 529 Plan
When selecting a 529 plan, first investigate your home state’s plan, as it may offer a state tax deduction or credit not available for out-of-state plans. You can also use online comparison tools to evaluate the investment options, historical performance, and associated fees of plans across the country.
Before applying, gather the necessary information for both the account owner and the beneficiary. You will need:
- Full legal name and physical address
- Date of birth
- Social Security Number (SSN) or Taxpayer Identification Number (TIN)
- Your bank account and routing number for contributions
The application is a straightforward online process on the chosen plan’s official website. During the application, you will set up your initial contribution and can establish an automatic investment plan for recurring savings. After submitting, you will receive a confirmation with your new account number and instructions for managing your account online.