529 Plan

What Is a 529 Plan?

A 529 plan is a savings account designed to help pay for education costs. Each plan is sponsored by a U.S. state or an educational institution and is authorized under Section 529 of the Internal Revenue Code. The account owner contributes money, which is invested, and the funds can be used for approved education expenses. Plans come in two main forms: prepaid tuition plans, which let families purchase future tuition at participating schools, and education savings plans, which invest contributions in portfolios of securities and are far more common.

How a 529 Plan Works

The account owner names a beneficiary, usually a child, and contributes over time. Investment earnings grow tax-deferred, meaning no federal income tax is owed on gains as they build up. When money is withdrawn to pay qualified education expenses, such as tuition, required fees, books, and certain room and board at eligible schools, the withdrawal is generally free of federal income tax. Many states also offer a state income tax deduction or credit for contributions, though the rules differ widely, and some states limit benefits to their own plan.

Education savings plans often offer age-based portfolios that become more conservative as the beneficiary nears college age, or static portfolios with a fixed mix of investments. The underlying holdings are typically mutual funds or similar funds. The owner can usually change the beneficiary to another eligible family member without triggering tax. Because a parent-owned 529 plan is generally reported as a parent asset on federal financial aid forms, it often has a smaller effect on aid eligibility than an account owned by the student.

Advantages and Disadvantages

Key points to weigh when considering a 529 plan:

• Tax-deferred growth and tax-free withdrawals for qualified education expenses
• The owner keeps control of the account, even after the beneficiary becomes an adult
• Contribution limits that are generally higher than those of some other education accounts
• Withdrawals not used for qualified expenses are subject to income tax on the earnings portion, plus a federal penalty on those earnings, generally 10 percent
• Investments carry market risk, and the account value can decline
• Fees, investment options, and state tax benefits vary by plan