Here’s everything you need to know.

By Lauren Phillips
Updated January 06, 2020
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Along with buying a house and saving for retirement, paying for college is one of the largest financial life milestones many people face. Getting that degree can set graduates up for success and higher wages throughout their lifetime, but it also comes with a huge price tag—one that keeps growing.

At the end of 2019, Americans had more than $1.5 trillion in outstanding federal loan debt, according to the U.S. Department of Education’s office of Federal Student Aid. FinAid, a free public information site, estimates that the current amount of student loan debt (including federal and private student loans) is more than $1.6 trillion, and 42.9 million people have federal loan debt. An analysis from the Pew Research Center found that one-third of people aged 18 to 29 have outstanding student loans for their own education. The median amount of outstanding debt was $17,000 in 2016, but that number can vary hugely based on education level; the median debt for those with bachelor’s degrees was $25,000.

All that is to say, student debt is a serious issue. If you graduated with student loan debt, you know the struggle of living with debt or working to pay it off. Carrying a huge student debt burden—especially if you also have credit card debt or another type of debt—can limit your ability to achieve financial independence and make reaching financial milestones (buying a house, getting married, starting a family) difficult.

If you don’t have student loan debt because your family, scholarships, and maybe your own savings paid for your education, you hopefully consider yourself lucky—and plan to pay the luxury of starting adulthood debt-free forward to your own children, should you have any. If you had a lot of debt when you graduated (and maybe still have it), you may hope to save your children from the same burden. Either way, the key to paying for college is planning ahead, and a 529 college savings plan may be the secret weapon you need to make paying for college possible.

You’ve likely heard of a 529 plan, at least in passing, but you may not understand how one can actively help you. “Many people don’t understand how they can use 529 accounts to pay for school,” says Misty Lynch, head of financial planning at John Hancock.

Betty Lochner, a spokesperson for the 529 for College campaign, which seeks to raise awareness of the benefits of 529 plans and increase participation, agrees. “[Most people] hear about them, but they don’t really understand how they work,” she says. Many people don’t realize they have options regarding their 529 account, and more don’t do their homework—or don’t know what to look for.

As with any financial goal or decision, understanding your options for 529 plans and doing your research is the key to success. If you’re curious about opening a 529—either for your own future education or for a child or grandchild—read on for everything you need to know about 529 college savings plans.

What is a 529 plan?

A 529 college savings plan is a tax-advantaged investment plan intended to help people save for education expenses. Any money deposited into a 529 plan will grow tax-free, and withdrawals are also tax-free when used for qualified expenses. These tax advantages—plus more benefits offered by various states—allow families to save money in an investment account without having to pay taxes on it.

529 plans are commonly referred to as such, but they are formally known as Qualified Tuition Programs, first defined in Section 529 of the Internal Revenue Code. The federal government established the concept of a 529, but plans are administered by individual states, state agencies, and a collection of colleges and universities. Forty-nine states and Washington, D.C., offer 529 savings plans, each with its own features. There is also a Private College 529 Plan and prepaid tuition plans or guaranteed savings plans, which are offered by certain states or higher education institutions.

How does a 529 plan work?

529 plans work by allowing money set aside for education to grow tax-free. 529s are often called savings plans, but they are truly investment accounts: The money stored in one will likely grow at a higher rate than it would when put in a savings account.

The primary benefit of a 529 is that money will grow more quickly in one. Ideally, a 529 will be created for a child when they are born. Regular deposits over 18 years (or until the child goes to college) will grow through investments and compound interest, so you’ll eventually have more money in the account than you saved. If you start early, that so-called bonus money can be quite a hefty sum.

The other key component of 529 plans is the tax advantages. Standard investments can be taxed on dividends, capital gains, and interest; distributions or withdrawals from an investment account are also taxed (if they’re sold for a profit). Money in 529 plans can grow free from federal income tax and withdrawals are tax-free, as long as they are used for qualified expenses, so families are able to invest their money without having to pay extra taxes on it. Unlike 401(k) plans, though, 529 deposits are post-tax: You will pay taxes on that money before transferring it to a 529 plan. (401(k) contributions are pre-tax.)

Some states offer more tax advantages and incentives (including tax breaks). Certain benefits vary by state: Because each state administers its own plan (excluding Wyoming, which does not offer a state-sponsored 529 college savings plan) and some states offer more than one, it’s important to understand what specific features your preferred plan offers.

A 529 plan can be opened by a family member for a beneficiary. Typically, parents or grandparents open them for children or grandchildren. Each plan needs one beneficiary, so a family saving for college for two children will need to open two separate 529 accounts. If one child chooses not to go to college, though, their 529 account can be transferred to the other child, or to another qualified family member. The person who opened the account remains in control of it for the duration, meaning they (not the beneficiary) ultimately decide how the money is used.

529 contribution limits and plan rules

Specific rules and limits for 529 college savings plans vary by plan and by state. (The College Savings Plan Network, a consortium of all states with 529 plans, has a comprehensive 529 plan comparison tool.) For the most part, though, total contribution limits are high: Many plans offer maximum contribution limits of $300,000 or higher, which is enough to cover expenses at nearly any four-year institution. Contributions to a 529 plan are considered a gift, Lynch says, so you can contribute up to the federal gift tax limit ($15,000 from a single donor per recipient in 2020) without having to report any additional contribution against your lifetime gift tax.

Funding a 529 account isn’t only the parent’s responsibility: Other family members can also contribute, and some plans make it easy by offering shareable links that interested parties can use to make one-click deposits to a child’s college savings. (Lynch points out that the ability to fund one account with contributions from several people is a huge advantage of 529 plans.)

Certain states have minimum initial contribution and subsequent contribution requirements. Some have no minimum requirements, while others have low ones. (Again, it varies by plan.) Most have little to no fees and offer a variety of investment options, including age-based, equity, fixed income, and more.

As long as withdrawals from a 529 are used for qualified, education-related expenses, they will not be taxed. An account owner can choose to withdraw the money for non-educational uses (in the event of a financial emergency, for example), but they will pay taxes and a penalty on it.

If a child doesn’t go to college or all the money in a 529 account isn’t used, the beneficiary of the account can be changed to a sibling, a cousin, the account owner (if they’re considering further education, for example), or held for a future grandchild. In that sense, the money is never wasted, and it can continue to be invested until it is used.

529 qualified expenses

The list of qualified expenses for a 529 plan is long. Qualified higher education expenses include tuition, mandatory fees, books, computers and internet access, supplies, and equipment required for enrollment or attendance; room and board can also be a qualified expense, pending certain allowances determined by the educational institution.

Similarly, the list of eligible institutions where 529 funds can be used for tuition is long: Money from a 529 savings plan can be used at almost any accredited college or university in the U.S. and even at some foreign schools, for students with an international bend.

As of 2018, a certain amount of money from a 529 can be used to pay tuition at private schools for children in kindergarten through 12th grade, though Brian Walsh, a certified financial planner at SoFi, says different states have different interpretations of the rule: Check with your plan to see what, if any, of your 529 funds you can put toward private school tuition for a non-college student.

Because there are tax implications for 529 distributions, you’ll want to keep a careful record of how you spend the money taken from a 529 account.

Is a 529 plan right for you and your family?

“With any savings goal, the earlier the better,” Walsh says. “Compounding returns are your best friend.”

In other words, taking advantage of a 529 plan is playing the long game: It’s committing to saving for college for several years. Lochner says most people open accounts when their children are six or seven years old, but, again, the earlier, the better. The longer money is invested, the more it grows, until however much you initially deposited is much larger than it was originally. The key to that growth is time, though. It’s never too late to open an account for college savings, but starting earlier means those funds will stretch further—and it means less of a savings burden on you.

“Even $10 a month over 18 years adds up,” Lochner says. “If you plan ahead and you’re consistent, it will make a huge difference.” She says she often hears that parents wish they’d created a 529 account for their child sooner.

That said, at SoFi—which offers free financial planning services to members—Walsh has members take a look at their overall finances before opening a 529 account.

“We focus on making sure that people have a solid financial foundation first,” he says. “As a planner, we want to make sure that people have their emergency funds set up already, they have their bad debt paid off, and they’re on track for their own retirement before they start setting aside money for their kids’ college.”

While hoping to protect your children from the student debt you may have struggled with is a worthy goal, it shouldn’t come at the expense of your own future, especially if your retirement savings aren’t on-track or you don’t have an emergency fund. Of course, it all comes down to priorities: If you’d rather put your money into your child’s education and figure out your own financial future later, that’s your prerogative. Figure out what you plan to accomplish financially, and then put your money where your goals are.

If you do have funds to set aside for college savings, a 529 account is an excellent choice, Walsh says. If you want extra savings to support your 529 account, for whatever reason, there are more options for college savings, too.

“There are several ways to pay for college that could complement a 529 plan, depending on your personal situation, i.e. age of your child, need for liquidity, etc.,” Lynch says. “A few options include savings and checking accounts, a Roth IRA, Custodial Account (UGMA/UTMA), and Coverdell Education Savings Account.” Of course, each account has its own pros and cons, so do your research before committing to one.

If you have time to play the long game and funds to set aside for college savings, a 529 plan might be the right choice for you—but you need to pick the right one.

How to pick a 529 plan

Most states offer a 529 plan—some offer more than one—and there’s also a private option, but that doesn’t mean you have to pick your state’s plan. In fact, Walsh and Lochner both say defaulting to your state’s plan isn’t always the best option, and both recommend shopping around for the plan most suited to your family’s goals and situation.

Some states offer special incentives (think tax breaks and contribution matching) to residents, so that’s certainly something to consider and be aware of. If your state doesn’t offer those, though, or you like the investment options a different plan offers, you’re free to pick that one. The various investment options each plan offers allow you to be as hands-on (or -off) as you’d like, so you can feel in control of the funds. If you prefer a particular investment strategy, be sure your preferred plan offers it before signing up.

Once you know what features you want from a 529 account, pay attention to plan fees, minimum contributions, and other logistical features: You want to make sure the plan is truly working for you.

Lochner says each state works hard to make signing up for a 529 easy, so once you pick a plan, creating the account should be simple. From there, it’s all about tucking away whatever you can to pay for a smarter future.