What Is a 529 Plan?

What Is a 529 Plan?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

A 529 plan is a tax-advantaged savings plan specifically designed to encourage savings for future education costs. Named after Section 529 of the Internal Revenue Code, states typically sponsor these plans. Parents, grandparents, or other family members can open a 529 plan for a child to save for their education. There are two types of 529 plans: college savings plans and prepaid tuition plans.

College savings plans work much like a Roth 401k or Roth IRA by investing your after-tax contributions in mutual funds or similar investments. As the account owner, you typically get to select the type of investment options for your contributions. These 529 plans can be used for undergraduate or graduate studies at any college, university, or vocational school that is accredited and eligible for federal financial aid.

The funds from a prepaid tuition plan can be used to pre-pay tuition at participating colleges and universities. Unlike a college savings plan, prepaid tuition plans allow the account owner to pay for future tuition costs at today’s prices.

Related Questions

1. What are the benefits of a 529 plan?

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529 plans offer several benefits. Any earnings in the 529 account grow federal tax-free and will not be taxed when money is taken out for education expenses. Some states also offer tax deductions or credits for contributions to 529 plans.

2. Can a 529 plan be used for K-12 education?

Yes, recent changes in legislation allow 529 plan savings to be used for K-12 tuition at private, public, or religious schools, with a $10,000 limit per year.

3. Can anyone contribute to a 529 plan?

Yes, anyone can contribute to a 529 plan. It makes for a great gift from grandparents, other family members, or friends.

4. What happens to the 529 plan if the beneficiary doesn’t go to college?

The account owner can change the beneficiary to another family member or even to themselves, ensuring the funds are still spent on education-related costs. There is also the option to withdraw the funds, but this comes with income tax on the earnings plus a 10% federal penalty tax.

5. Is there a limit to how much I can contribute to a 529 plan?

While there is no annual contribution limit, there is a maximum limit that varies by state, which is usually between $235,000 and $520,000. This limit refers to all contributions made to the 529 plans for a single beneficiary.