Introduction to education savings: What is a 529 plan?
Key takeaways
A 529 plan allows families to put money aside to help pay for qualified educational expenses
529 earnings grow tax-free, and withdrawals are tax-free when used for qualified expenses¹
529 earnings can be used to pay for a wide range of education costs
Don’t know what a 529 plan is or want to know more about it? We’ve got you covered. Read on for answers to some common questions about 529 savings plans.
What is a 529 plan?
A 529 plan (named after the section of the IRS tax code the plan comes from) is an education savings plan that allows families to put money aside to help pay for qualified educational expenses. There are two types of 529 plans:
- Prepaid 529 plan. A prepaid 529 allows families to prepay future college (typically public and in-state schools) costs at today’s rates.
- 529 savings plan. While only a few states have prepaid 529 options, every state offers a 529 savings plan. A 529 savings plan allows families to contribute money into a savings account and let that money grow through various investment options and portfolios to pay for education expenses.
Is a 529 plan just for college?
No. A 529 can be used to pay for education expenses starting at grades K-12, not just college costs.
How does a 529 plan work?
A 529 plan is available for all US residents regardless of income. Anyone over 18 with a US mailing address and Social Security number can open a 529.
Once a 529 is opened, the account owner assigns a beneficiary to the account. As contributions and investments help grow the account, the account owner can pay out qualified educational expenses directly. The beneficiary doesn’t handle any of the money.
If there is money remaining in the 529 account, or the beneficiary gets a full scholarship, a new beneficiary can be named to use those funds. The beneficiary can even be the account owner.
Is a 529 plan tax-free?
Yes. All earnings made on a 529 are tax-free. Making withdrawals for qualified educational expenses is also tax-free.1 In addition, many states also offer tax advantages in the form of tax deductions or tax credits if you have an in-state 529 plan.
What expenses does a 529 plan cover?
A 529 is used to pay for “qualified education expenses.” These can include the following:
- Tuition and fees
- Books
- Supplies and equipment
- Room and board, in some cases
- Expenses for special needs services
Do I have to use my state’s 529 plan?
No. While there can be tax advantages to using an in-state 529 plan, it’s not mandatory. Since each state deals with 529 plans differently, some states don’t offer tax advantages for their 529 plans. If that’s the case for you, look at other states’ plans to find one that could be cheaper to use.
Footnotes
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1
Earnings on non-qualified withdrawals may be subject to federal income tax and a 10% federal penalty tax, as well as state and local income taxes. Tax and other benefits are contingent on meeting other requirements and certain withdrawals are subject to federal, state, and local taxes.
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