529 plans explained: how to save for college tax-efficiently

Short answer: a 529 plan is a US education savings account where your money grows tax-free and withdrawals are tax-free when used for qualified education costs such as tuition, fees, books and room and board. Contributions are not deductible on your federal return, but many states offer a state tax deduction or credit. If the beneficiary does not use all the money, you can change the beneficiary, use it for other qualifying costs, or, within limits, roll part of it into a Roth IRA.

How does a 529 plan work?

You open an account with a state-sponsored plan, name a beneficiary (often your child, but it can be yourself or anyone), and invest the contributions in a menu of funds, usually index-based portfolios and age-based options that shift from stocks to bonds as college approaches. The money grows without annual tax. Withdrawals used for qualified expenses are not taxed at the federal level. You stay in control of the account as the owner, not the child.

What counts as a qualified expense?

• Tuition and mandatory fees at eligible colleges, universities, and many trade and vocational schools.
• Books, supplies and required equipment, including a computer used for school.
• Room and board for students enrolled at least half time, up to the school's allowance.
• Up to a yearly cap of tuition at K-12 schools, a limit that has been raised in recent legislation, so check the current figure.
• Some student loan repayment, up to a lifetime limit, and certain apprenticeship costs.

If you withdraw for something that does not qualify, the earnings portion is taxed as income and generally hit with a 10% penalty, though the penalty is waived in some cases, such as when the beneficiary receives a scholarship.

What are the tax advantages?

Check your own state's rules before you pick a plan, because the state tax break can decide which plan is best for you.

How much will regular saving build?

Saving $200 a month from birth for 18 years at a hypothetical 6% yearly return grows to about $77,500 on $43,200 of contributions. Saving $500 a month would grow to about $194,000. The return is an assumption, not a guarantee, and you may also choose a more conservative path as college approaches. Costs vary widely: a public in-state degree costs far less than a private one, so use realistic targets. A common aim is to cover a share of costs rather than all of it, mixing savings, income, scholarships and possibly some borrowing.

Does a 529 affect financial aid?

A 529 owned by a parent is treated as a parent asset on the federal aid form, and it is assessed at a maximum of about 5.64% of its value when calculating expected family contribution, which is far lighter than student-owned assets. Accounts owned by grandparents have been treated differently under recent form changes, so check how current rules affect your case.

What if the money is not all used?

• Change the beneficiary to a sibling, another family member or yourself, with no tax or penalty.
• Keep it for graduate school or later education.
• Roll over to a Roth IRA in the beneficiary's name, under SECURE 2.0 rules: up to a lifetime limit of $35,000, the account must have been open at least 15 years, and annual Roth contribution limits apply.
• Withdraw it, paying income tax and the 10% penalty on earnings only.

Common mistakes

• Saving for college before your own retirement. There are loans for college, but no loans for retirement. Take the employer match and fund retirement first.
• Choosing a plan with high fees. Compare expense ratios, as with any fund. See how fees eat returns.
• Staying aggressive too close to enrollment. Use an age-based portfolio or shift to safer assets over the last few years.

Not sure how a college savings goal fits with everything else? Use our financial plan report to see the trade-offs, or check progress with the calculators.

General education, not tax or investment advice. Plan rules and legislation change, so confirm details with your state's plan and a qualified professional.

Frequently asked questions