What is a 529 Plan for College for 2025?
Co-Founder and Chief Data Scientist
Going to college is not cheap. The costs connected to higher education have increased significantly from 2001 to 2020. Aside from tuition and fees, students need to pay for textbooks, food expenses, and transportation. There’s also board and lodging so many students ask what does room and board include? when analyzing the cost of college.
Even so, students and their families find ways to overcome financial challenges to obtain a college degree. Scholarships, grants, and other financial aid can be extremely helpful in reducing the costs of going to college.
Families and even friends and sponsors can reduce their worries about rising tuition costs with the help of a 529 plan. But what is a 529 plan and what does it entail? Read on to know more about this beneficial education-focused plan that has helped millions secure their future.
The 529 Plan: Table of Contents
- Overview of 529 Plan
- Short History of 529 Plan
- 529 Plan Today
- Benefits of a 529 Plan
- How Does Your College Major Choice Impact Your 529 Plan’s Long-Term Benefits?
- Can a 529 Plan be Used for Online Colleges?
- Can a 529 Plan Help With Graduate Education Expenses?
- What are the potential risks associated with a 529 plan?
- How Can Nontraditional Degree Options Enhance Your 529 Plan Strategy?
- Can accelerated degree programs enhance your 529 plan strategy?
- How Can 529 Plans Complement Other Financial Aid Options?
- Deciding to Get a 529 Plan
Overview of 529 Plan
When encountering it for the first time, one may ask what is a 529 plan and why is it a big deal? A 529 plan is a tax-advantaged savings plan designed specifically for educational purposes. It was initially intended to help students in college or university. However, in 2017, it was broadened to include K-12 pupils. Two years later, students in apprenticeship programs were added as beneficiaries (Kagan, 2020).
Legally, a 529 plan is called a “qualified tuition plan," according to the U.S. Securities and Exchange Commission (2018). The plan is subsidized by schools, colleges or universities, state institutions, and by states themselves. It gets its name from Section 529 of the Internal Revenue Code. More about the difference between schools, colleges, and universities in the US.
But while these plans are for education purposes, they are not overseen by the U.S. Department of Education (U.S. Department of Education, n.d.).
As of June 2019, the total number of 529 plan assets increased by 7% year-over-year to $352 billion, while the total number of 529 plan accounts rose by 3% versus the previous year to reach 14 million (Flynn, 2019). At present, the average account balance is $25,615.
Short History of 529 Plan
The first-ever iteration of the 529 plan for college started in the state of Michigan in the 1980s. It came about because of the rising costs of tuition every year. Thus, the state set up the Michigan Education Trust to alleviate the worries of households regarding the future education of their children.
Residents paid a fixed amount towards the fund with the guarantee that the state-run Trust would pay the tuition cost when a child reaches college age and enrolls at any public college or university in Michigan. Other states that were pioneers of 529 plan precursors were Florida, Ohio, and Wyoming (529 College Savings Plans, n.d.).
That sparked interest from other states and Congress created the 529 plan in 1996 (Internal Revenue Service, 2020).
529 Plan Today
There are two types of 529 plans: prepaid tuition plans and education savings plans. Investor.gov (n.d.) noted that all 50 states, as well as the District of Columbia, sponsor at least one kind of 529 plan. But how do these two differ?
Prepaid Tuition Plan
This type of plan allows partakers to purchase beforehand the future tuition of a child at the current rate. They can pre-pay from one to four years of tuition. 529 College Savings Plan (n.d.) wrote that this means the accumulated amount goes towards the current tuition rate when a child reaches college age. It is offered by states, educational institutions, and state agencies.
Additionally, there are two kinds of prepaid tuition plans. The contract plan is the most common. It allows account holders to exchange upfront or staggered payments to cover a certain amount of tuition in the future. It has a formula that calculates how much the plan will cover.
The other kind is the unit plan, which is applicable to any participating higher education institution. The account holder can purchase units or credits for a percentage of their selected college’s tuition cost. The value of these units or credits changes per year depending on the changes in the tuition. When the time comes, account holders can redeem these credits to pay for tuition, as well as textbooks, school supplies, room and board, and other education-related expenses (Boston.com, 2012).
Savings Plan
College savings plans are similar to investment plans. Account owners put their money on mutual funds that can grow over the years based on market performance. They can select age-based investments that become more conservative as the child reaches college age. It is offered only by states.
States and the Type of 529 Plan They Offer
It should be noted that each state has its own 529 plan structure. Thus, students or parents who want to take advantage of the program can check their respective states’ websites to be clear about the rules.
While plans are generally for in-state students, there are also plans that allow investors from other states. However, non-state residents cannot enjoy certain benefits that in-state residents do.
There are 19 states offering prepaid tuition plans while 50 states, plus the District of Columbia have savings plans (Board of Governors of the Federal Reserve System, 2020).
Benefits of a 529 Plan
Fifty-six percent of American parents were already saving for the college education of their children in 2018. This went down by 1% from the 2016-2017 period. Nevertheless, it looks like there are many parents who are eager to benefit from a college savings plan since higher education costs are going up.
A 529 plan, being tax-advantaged, means that it is not subject to any tax related to higher education expenses like tuition, books and school supplies, mandatory equipment, and digital devices such as computers, internet access, and educational software or applications. my529 (2016) points out that it also covers K-12 tuition at private, public, and sectarian schools. Having a 529 plan can also be advantageous, as account holders can enroll in a program at any time of the year. Thus, they can get started as soon as they decide to apply to a 529 plan.
Moreover, a 529 plan does not require federal income taxes when invested and when withdrawn for qualified expenses. According to Putnam Investments (2019), at least 34 states have additional tax incentives. Other unique benefits of 529 plans include the offset of estate taxes and the exclusion from special gift tax. For the former, 529 plan contributions can be removed from the estate yet the account holder retains control. For the latter, account holders can offer five years’ worth of gifts to one beneficiary without paying the federal gift tax. In 2019, the maximum for individuals was $75,000 while the maximum for married couples was $150,000.
Investing in a 529 plan also relieves some of the stress of parents saving up for the education of their children. Grandparents and other relatives, even friends, can pitch in as well for the education of a loved one or of a person they wish to help (Fidelity Investments, n.d.).
How Does Your College Major Choice Impact Your 529 Plan’s Long-Term Benefits?
Aligning your education savings strategy with a college major that offers strong career prospects can significantly enhance the overall value of your 529 plan. By assessing the earning potential of various fields and considering market trends, families can ensure that investments serve not only current tuition needs but also long-term financial goals. For instance, reviewing data on what degrees make the most money provides insight into which fields may yield higher returns and more stable career opportunities. Evaluating degree programs based on projected job growth, required skills, and future income potential supports a data-driven approach that complements your 529 plan strategy and improves overall educational investment outcomes.
Can a 529 Plan be Used for Online Colleges?
Many accredited online colleges meet the qualifications for institutions where 529 funds can be applied. Account holders should verify that an online institution is accredited by recognized agencies and that its programs are eligible for federal financial aid. In addition, ensuring that all related expenses fall under qualified education costs is essential to avoid penalties. Consulting with a financial advisor can provide clarity on using education savings effectively for digital learning environments while maintaining compliance with regulatory standards.
Can a 529 Plan Help With Graduate Education Expenses?
Graduate education expenses at accredited institutions qualify as eligible costs under a 529 plan. Funds may cover tuition, fees, and necessary supplies for advanced degree programs, thus extending the plan’s utility beyond undergraduate studies. Families should review their state’s guidelines to ensure compliance with specific requirements while planning contributions effectively. Additionally, evaluating data on advanced degree expenses, such as that covered in our guide on PhD cost USA, supports a strategic approach to managing long-term educational investments.
What are the potential risks associated with a 529 plan?
A 529 plan’s investment component, especially in education savings plans, is subject to market volatility and changing interest rates, which can influence long-term growth. Policy changes at state or federal levels may also adjust tax benefits or contribution limits, directly impacting returns. Additionally, plan-specific fees and limited investment options might restrict flexibility. Evaluating these risks in the context of one’s overall education funding strategy is essential, as is considering alternative investments and career paths, including data on the highest paying bachelor degrees entry-level programs, for a comprehensive financial planning approach.
How Can Nontraditional Degree Options Enhance Your 529 Plan Strategy?
Emerging educational models—such as online, competency-based, and accelerated programs—can complement a 529 plan by shortening the time to degree completion and reducing overall educational expenses. For instance, opting for an accelerated bachelor's degree may offer a faster pathway to the workforce along with a more efficient use of tax-advantaged savings. Aligning these alternative degree options with your 529 plan strategy can help maximize investment efficiency while adapting to evolving career and education trends.
Can accelerated degree programs enhance your 529 plan strategy?
Accelerated degree programs offer a streamlined pathway to completing a qualification, potentially reducing overall educational costs and the time during which tuition rates may rise. By shortening the duration of coursework, families can align their 529 plan contributions more efficiently with the actual period of academic expenses. In addition, fewer academic terms can decrease exposure to market risks associated with long-term investment fluctuations in education savings. For individuals seeking a fast-track option, exploring programs such as What is the fastest degree to get online? can provide an opportunity to balance educational investments with quicker entry into the workforce.
How Can 529 Plans Complement Other Financial Aid Options?
A well-rounded education funding strategy often combines 529 plans with scholarships, grants, and federal loans to address varying expense types and timing of disbursements. Integrating a 529 plan with merit-based or need-based aid can optimize tax advantages while reducing reliance on student loans. Evaluating the eligibility criteria, disbursement schedules, and tax implications for each funding source enables families to balance risk and liquidity. Leveraging cost-effective educational pathways—such as exploring cheapest online colleges for working professionals—further enhances the overall affordability of higher education without compromising quality.
What are the alternatives to a 529 plan?
While a 529 plan offers tax advantages for education savings, it’s not the only option for families. Here are some alternatives to consider:
- Coverdell Education Savings Account (ESA): This account allows contributions up to $2,000 per year per beneficiary, with tax-free withdrawals for qualified education expenses. Coverdell ESA funds can be used for K-12 expenses, as well as college costs.
- Roth IRA: Originally intended for retirement savings, Roth IRAs allow you to withdraw contributions tax-free for qualified education expenses, providing more flexibility than a 529. However, Roth IRAs come with annual contribution limits and income restrictions.
- UGMA/UTMA Custodial Accounts: These accounts enable parents to transfer assets to minors without creating a trust. While they offer flexibility in spending, earnings are subject to taxes, and funds may impact financial aid eligibility.
- Scholarships and Grants: Many institutions offer scholarships and grants based on academic performance, sports, or financial need. Exploring these options can help reduce college expenses without requiring repayment.
Each option comes with unique benefits and considerations, making it essential to evaluate based on specific family financial goals and circumstances.
Deciding to Get a 529 Plan
Who is Eligible
Anyone is entitled to a 529 account plan as long as he or she is a U.S. citizen or a resident alien. Account owners can choose the beneficiary of the investment and decide how the money is to be used (529 basics, n.d.).
Additionally, those who want to open a 529 account must be at least 18 years old, has a U.S. address, and has a Social Security number or Tax I.D. There are no income restrictions as well, so regardless of the state of life of an individual, that person can open a 529 plan account as long as he or she has the necessary documents (Fidelity Investments, n.d.).
Rules to Remember
To take full advantage of the benefits of a 529 plan, account holders must follow the 529 plan rules. One of the most important rules is to make withdrawals for eligible expenses only. Education expenses that are considered qualified include computer software and hardware used for learning, textbooks, on-campus and off-campus board, etc.
In case the account holder makes an unqualified withdrawal, that individual will incur a 10% penalty, Schramm (2019) explains. On top of that, the earnings become subject to federal income taxes. Additionally, it is possible that account holders would have to pay any state income tax breaks they benefited from because of the contributions.
But what happens if the original beneficiary does not need all the money? In that case, account holders have the option to withdraw the remaining amount or to assign it to another beneficiary. Again, the withdrawal would be subjected to taxes. If the account holder opts to utilize the balance for a new beneficiary, then the account holder does not incur any penalty.
Still, account holders have to note that when choosing a new beneficiary, that person has to be a member of the original beneficiary’s family. The definition is broad and can include first cousins, stepsiblings, and even in-laws.
It Pays to Save for the Future
Families can send their children to the best schools, starting from primary age. With the 529 plan, they can ensure that they have money to allocate to tuition and other educational expenses. And if their 529 plans are meant for college costs, then families can start investing early. That way, they can make sure to afford to send their children to out-of-state and even private schools or even top US college that pay off the most.
If families are worried about the risks involved in the investment, then they can choose age-based investment options, whose risks are lower as the beneficiary approaches college age. With this, they can rest assured that their investments are safe and can pay for college costs and possibly graduate school expenses.
Key Insights
- Rising Costs of Higher Education: The cost of attending college has increased significantly from 2001 to 2020, encompassing tuition, fees, textbooks, food, transportation, and lodging.
- Financial Aid and 529 Plans: Scholarships, grants, and 529 plans are vital in helping families manage and reduce the financial burden of higher education.
- Understanding the 529 Plan: A 529 plan is a tax-advantaged savings plan specifically for educational purposes, covering college, K-12, and apprenticeship programs.
- Types of 529 Plans: There are two main types of 529 plans: prepaid tuition plans, which allow prepayment of future tuition at current rates, and education savings plans, which function similarly to investment plans.
- State-Specific Plans: Each state offers different 529 plans, and some provide benefits to in-state residents that are not available to out-of-state investors.
- Tax Benefits and Contributions: Contributions to 529 plans can offer tax benefits, including avoidance of federal income taxes on qualified withdrawals and potential state tax incentives.
- Flexibility and Rules: Account holders can change beneficiaries within the family and must adhere to rules regarding qualified educational expenses to avoid penalties.
FAQ
What is a 529 plan and why is it important?
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. It is important because it offers tax benefits and flexibility in saving for educational expenses, which can significantly reduce the financial burden of higher education.
What expenses are covered by a 529 plan?
Qualified expenses include tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution. Room and board, computer technology, and internet access for students are also covered.
What are the two types of 529 plans and how do they differ?
The two types of 529 plans are prepaid tuition plans and education savings plans. Prepaid tuition plans allow the prepayment of tuition at current rates for future use, while education savings plans are investment accounts that grow over time to cover educational expenses.
Are 529 plans available in every state?
Yes, all 50 states and the District of Columbia offer at least one type of 529 plan. Each state has its own structure and benefits, so it's essential to review the specific details of the state's plan.
Can 529 plan funds be used for K-12 education?
Yes, since 2017, 529 plan funds can be used for K-12 tuition at private, public, and religious schools, in addition to college and university expenses.
What are the tax advantages of a 529 plan?
Contributions to a 529 plan grow tax-free, and withdrawals for qualified educational expenses are also tax-free. Additionally, many states offer tax deductions or credits for contributions to a 529 plan.
What happens if the beneficiary does not use all the funds in a 529 plan?
If the beneficiary does not use all the funds, the account holder can change the beneficiary to another qualifying family member without penalty. Alternatively, the funds can be withdrawn but will be subject to taxes and a 10% penalty on earnings for non-qualified expenses.
Who is eligible to open a 529 plan?
Any U.S. citizen or resident alien over the age of 18 with a Social Security number or Tax ID can open a 529 plan. There are no income restrictions for opening or contributing to a 529 plan.
Can multiple people contribute to a single 529 plan?
Yes, multiple people, including parents, grandparents, relatives, and friends, can contribute to a single 529 plan account, making it a flexible option for funding a beneficiary's education.
How can I maximize the tax benefits of a 529 plan for my education expenses?
To maximize the tax benefits of a 529 plan, contribute as early and consistently as possible, allowing your investment to grow tax-free over time. Earnings in a 529 plan are not subject to federal income tax when used for qualified education expenses, including tuition, fees, books, and room and board. Additionally, some states offer tax deductions or credits for contributions to the plan. To fully benefit, ensure withdrawals are used only for qualified expenses to avoid taxes and penalties. Regularly review your plan’s investment options and consider adjusting them based on your time horizon and financial goals to optimize growth.
References
- NY’s 529 CSP (n.d.). 529 Basics. NYSaves.org.
- CSPN (n.d.). History of 529 Plans. Washington, DC: College Savings Plan Network.
- CSPN (n.d.). What is a 529 Plan? Washington, DC: College Savings Plan Network.
- Boston Globe (2012, June 11). Understanding the Two Types of 529 Plans. Boston, MA: Boston Globe Media.
- BLS (2019, September 4). Unemployment rates and earnings by educational attainment. Employment Projections. Washington, DC: U.S. Bureau of Labor Statistics.
- Flynn, K. (2019, September 27). Families are saving more than ever in 529 plans. Saving for College.
- Fidelity (n.d.). What is a 529 Plan? Boston, MA: Fidelity Investments.
- Investor.gov. (n.d.). 529 plans. Washington, DC: U.S. Securities and Exchange Commission.
- Kagan, J. (2020, February 4). Complete guide to 529 plans. Investopedia.
- Putnam (2019). 529 Plan. Boston, MA: Putnam Investments.
- Schramm, M. (2019, October 22). What is a 529? Morningstar.com.
- ED (n.d.). FAQs: Frequently Asked Questions. Washington, DC: U.S. Department of Education.
- SEC (2018, May 29). An Introduction to 529 Plans. Washington, DC: U.S. Securities and Exchange Commission.
