What Are the Tax Advantages of a 529 Plan?

A 529 plan is an investment account designed to help families save for education costs. Named after Section 529 of the Internal Revenue Code, these state-administered accounts allow individuals to invest after-tax contributions. The funds can be applied to a wide range of institutions, including community colleges, trade schools, and graduate programs.

Federal Tax Benefits on Earnings and Withdrawals

The primary federal tax advantage of a 529 plan is how investment earnings are treated. While contributions are made with money that has already been taxed, the investments within the account grow on a tax-deferred basis. This means that as the account’s value increases, no federal income taxes are due on those earnings annually, allowing the funds to compound more effectively over time compared to a standard taxable account.

To illustrate, consider an investment of $5,000 with monthly contributions of $200 for 15 years. In a taxable account with a 6% annual return and a 24% tax bracket, the account might grow to about $65,000 after taxes on gains are paid. In a 529 plan, the same investment could grow to over $75,000, demonstrating the benefit of tax-deferred growth.

The second federal benefit occurs when funds are withdrawn for qualified education expenses. These withdrawals are entirely free from federal income tax. This tax-free treatment applies to the original contributions and all the accumulated investment earnings.

State Income Tax Deductions and Credits

In addition to federal benefits, many states offer their own tax incentives for 529 plan contributions. Over 30 states provide either a state income tax deduction or a tax credit. These incentives are designed to encourage residents to save for education by providing an immediate tax reward.

A state income tax deduction reduces your total taxable income, lowering your state tax liability by a percentage. In contrast, a tax credit provides a dollar-for-dollar reduction of your state tax bill and is often more impactful.

An important factor is whether your state requires you to use its in-state plan to qualify for the tax break. Most states mandate the use of their own plan. However, a few “tax-parity” states allow residents to claim a benefit for contributions to any state’s 529 plan, offering more flexibility to find plans with lower fees or better performance.

Gift and Estate Tax Considerations

A 529 plan offers advantages for gift and estate tax planning. Contributions are considered completed gifts to the beneficiary for tax purposes. This means the funds are removed from the contributor’s taxable estate, which can be a strategy for those concerned about estate tax liability.

Under federal law, individuals can contribute up to the annual gift tax exclusion amount each year without incurring gift taxes. For 2025, this amount is $19,000 per individual or $38,000 for a married couple. This allows for substantial contributions while reducing the value of one’s taxable estate.

A feature of 529 plans is the ability to “superfund” an account. This allows a contributor to make a lump-sum contribution of up to five times the annual exclusion amount—$95,000 for an individual or $190,000 for a married couple in 2025—and treat it as if made over five years. The contributor must file a Form 709 gift tax return to make the five-year election, but no gift tax is due.

Maintaining Tax-Advantaged Status

To preserve the tax benefits of a 529 plan, funds must be used for approved purposes. Withdrawals are federally tax-free only when used for Qualified Higher Education Expenses (QHEE). These include tuition, mandatory fees, books, supplies, and required equipment at an eligible postsecondary institution. Room and board costs also qualify if the student is enrolled at least half-time.

Recent legislative changes expanded the definition of qualified expenses. Account owners can withdraw up to $10,000 annually per beneficiary for K-12 tuition. Funds can also be used for registered apprenticeship programs and to repay student loans, with a lifetime limit of $10,000 per beneficiary and for each of their siblings.

Using funds for anything other than a qualified expense results in a non-qualified distribution. The earnings portion of this withdrawal is subject to ordinary income tax at the recipient’s rate, plus a 10% federal penalty tax. State income taxes and penalties may also apply to the earnings.

A provision from the SECURE 2.0 Act offers an option if funds are not needed for education. Under specific conditions, money from a 529 account can be rolled over tax-free to a Roth IRA for the beneficiary. This rollover has a lifetime maximum of $35,000, and the 529 account must have been open for at least 15 years.