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A 529 plan is a type of college savings account that helps you save on taxes while putting money away for college. While it’s a good idea to start saving as early as possible, you can start a 529 plan for your child or yourself at any time.
Here’s what you need to know about 529 plans:
- There are two types of 529 plans
- 529 plans can only be used for qualified college expenses
- Beware of 529 withdrawal penalties
- A 529 plan could impact a student’s financial aid package
- 529 plans can help students reduce the need to borrow for college
There are two types of 529 plans
Before you sign up for a 529 plan, it’s important to learn about the two different types. Here’s how both of them work:
- Education savings plan: The typical 529 plan account works a lot like a Roth IRA. While you don’t get a tax deduction for contributions, withdrawals are tax-free as long as you use the funds for qualified education expenses. This lets you avoid capital gains taxes on your college savings.
- Prepaid tuition plan: A prepaid tuition plan allows you to save over time for your child’s education while locking in current tuition rates at certain schools. Because the cost of college tends to go up over time, this can lead to significant savings. But keep in mind that this type of plan only applies to participating public in-state colleges and universities, which means making a long-term commitment to those schools.
All states offer some form of 529 plan, according to the U.S. Securities and Exchange Commission (SEC). Keep in mind that while all states sponsor education savings plans, only 12 sponsor prepaid tuition plans. A large group of private colleges and universities throughout the U.S. offer private prepaid tuition plans, too.
Most state 529 plans are available online. Head to the appropriate state’s website to sign up for the plan you’re interested in. Just like with any other financial account, you’ll need to enter both your personal contact and financial information (like your Social Security number) to start a new account.
|Educational savings plan
|All 50 states
(including the District of Columbia)
|Prepaid tuition plan
|FL, IL, MD, MA, MI, MS, NV, PA, TN, VA, TX, and WA
529 plans can only be used for qualified college expenses
A 529 plan can help you save for college and avoid taking out student loans, but there are strings attached. You can use it only for qualified education expenses — and for up to only $10,000 per year.
Funds are eligible for use at accredited colleges, universities, vocational schools, or other postsecondary educational institutions. Costs related to K-12 elementary or secondary public, private, and religious schools are also covered.
Beware of 529 withdrawal penalties
The tax benefits of a 529 plan are available only if you follow the rules. Saving and investing for a decade or more can lead to significant investment gains — and a 529 plan makes them tax-free. But if you withdraw early or for nonqualified expenses, you’ll have to pay taxes and a 10% penalty on gains.
But don’t worry — if you have leftover money in a 529 plan, you have some options to withdraw without any penalties.
What happens if the 529 plan isn’t used?
If you don’t end up using your 529 plan (maybe your child doesn’t go to college), you might have a significant balance left over. If this happens, you can transfer a 529 account to another beneficiary whenever you’d like. The new beneficiary can be a different child or family member — or even yourself. For example, if you’d like to take an art or business class at a local community college, you could draw on your unused 529 plan funds for it.
What happens if there is leftover money in the 529 account?
You can always withdraw funds from a 529 plan if you’re willing to pay taxes on the gains and a 10% penalty. But it’s a good idea to consider other options first. For example, the beneficiary can use up to $10,000 for student loan repayment.
You can also transfer the plan (or what’s left of it if it’s been partially used) to a new beneficiary, such as another child or family member, and keep the benefits.
Learn More: Do Student Loans Count as Income on My Taxes?
A 529 plan could impact a student’s financial aid package
It’s important to keep in mind how your assets from saving and investing could impact future financial aid. More savings means less financial need, which could disqualify your child from certain scholarships and loan options.
When filling out the FAFSA (Free Application for Federal Student Aid), you’ll get an Expected Family Contribution (EFC), which is how much your family is expected to pay toward college. This number takes your assets into account — including any 529 plans with you or your child as the account holder. Also remember that 529 plan withdrawals count as income for the student, which could affect financial aid packages, too.
If a 529 plan is held by a grandparent, it’s not included in the EFC. In this case, it might make sense to transfer the account to the parents or just make contributions to a parent-owned account. This is because assets have a lesser impact on financial aid than income from 529 plan withdrawals.
529 plans can help students reduce the need to borrow for college
If you start saving $25 per month when your child is born, you’ll end up with $5,400 toward their education after 18 years. And if you assume a 7% annual return, the account will ultimately be worth $10,768. With better investment performance and higher contributions, you could save enough to cover a good chunk of a college education.
Parents often use Parent PLUS Loans to help their child pay for school, but these aren’t always the best deal. If you have excellent credit, you might qualify for a better interest rate with a private student loan. If you decide to take out a private student loan, be sure to consider as many lenders as possible to find the right loan for you.
Credible makes this easy — you can compare prequalified rates from multiple private student loan lenders in just a few minutes.