529 College Savings Plans - COLLEGEdata - Pay Your Way

529 College Savings Plans

State-sponsored 529 plans are the stars of college savings. They offer tax breaks, high investment limits, and considerable flexibility. Here's what you need to know up front before you invest.

Two Types of Accounts

The federal government established two types of 529 plans (also called "Qualified Tuition Programs"): savings plans and prepaid tuition plans.

529 college savings plans can be used to pay for most expenses at most colleges. They offer investment options similar to regular stock market accounts in that they can earn or lose money and investments are not guaranteed by the FDIC or state government. You can usually choose from a variety of funds and leave administration of the account up to the plan manager. Plans are state-sponsored but usually managed by an experienced investment company.

529 prepaid tuition plans are guaranteed to cover future college tuition at today's prices. State-sponsored plans in a little over a dozen states offer guaranteed tuition coverage at a public college in that state. The funds can also be transferred to private or out-of-state colleges but are not guaranteed to cover their tuition. More than 270 private colleges also offer a nationwide prepaid tuition plan called the Private College 529 Plan. (To find a list of participating colleges, visit privatecollege529.com.)

Rules for Withdrawing Money

Withdrawals must be used to pay for "qualified education expenses." Withdrawals of earnings on a 529 plan are tax- and penalty-free only if they cover the qualified college expenses of the student. For prepaid tuition plans, qualified expenses include tuition, fees, books, supplies, and required equipment at eligible institutions. Savings plans can cover these same expenses, plus room and board expenses as determined by the college.

Plan carefully. If you are paying for some college expenses with a scholarship or other financial aid, or you wish to claim an education tax break, you must plan your 529 withdrawals with care. Withdrawals from 529 accounts can't be used to pay for the same expenses already covered by tax-free financial aid or scholarships, or that you plan to use to qualify for an education tax break. See IRS publication 970 for details. Don't forget that your state may have additional rules for withdrawing money. Consult your state taxation office for more information.

Be aware of taxes and penalties. Early withdrawals or withdrawals for expenses not related to the college education of the beneficiary are subject to federal income taxes plus a ten percent penalty. The penalty is waived if the beneficiary dies or becomes disabled before attending college. But what if the student does not attend college, or gets a scholarship? See "If the Student Doesn't Need the Money" later in this article.

Effects on Financial Aid

Low impact on aid eligibility. Both 529 savings and tuition accounts owned by parents are treated as parent assets on the Free Application for Federal Student Aid, or FAFSA. This means the accounts have a relatively small impact on financial aid eligibility. Accounts owned by dependent students must also be reported as parent assets. Accounts owned by independent students, however, must be reported as student assets. (For more information about how student and parent assets factor into financial aid, read our article Does It Matter Whose Asset It Is?)

Withdrawals are not counted as income. The government does not consider withdrawals from 529 accounts owned by a parent or dependent student as income in calculating financial aid eligibility.

Grandparents and others may hold their own accounts. Accounts owned by people who are not the parents or the student are not reported as assets on the FAFSA. Withdrawals from such accounts that are spent on the student are counted as student income, which can reduce aid eligibility by as much as 50 percent of the amount withdrawn.

The accounts may impact financial aid at private colleges. Many private colleges use another financial aid application called the CSS/Financial Aid PROFILE, and it may ask about all 529 accounts that benefit the student, regardless of ownership.

Tax Rules

Tax-deferred and tax-free. Investments in 529 plans grow tax-deferred. Even better, funds used to pay for eligible college expenses are federal tax-free. Up to $14,000 per year placed in an account is not even considered part of the investor's estate for federal tax purposes.

Tax-free limits. These tax advantages apply only to legitimate college expenses, as defined by each plan. If investors withdraw more money than needed for such expenses, they expose themselves to income tax liability.

State tax-deductible. Some states allow state residents to deduct a portion of their deposits to these accounts on their state tax returns.

Investment Rules

Investment changes allowed. Investors are allowed to change their strategies, but only once per year. Investments can also be changed under certain special circumstances, such as a change in beneficiary or a rollover from another state plan.

Many plans offer investment allocations that become more conservative as the student gets older. Adopting this strategy preserves the money as you get closer to actually using it for college.

Anyone can invest. Although each account has only one person or married couple as owner, anyone over 18 can open and/or contribute to a 529 account. Unlike other forms of saving for college, it doesn't matter what the annual incomes of the plan contributors are.

Multiple accounts are okay. Families in which more than one child will be going to college may open a separate account for each child, and different people may open multiple accounts for a single child so that each investor receives his or her own tax benefits.

Investment limits are generous. An investor can open a 529 savings account with as little as $25 and can keep adding deposits up to $14,000 a year (or $28,000 a year for joint filers) without incurring a gift tax. (Contributions to a 529 plan are considered "gifts" to the beneficiary of the plan.) Alternatively, an investor may choose to make a one-time contribution of up to $70,000 ($140,000 for joint filers) that can be distributed over five years. They may make no further contributions to the plan during that five-year period. After five years, the investor can keep adding deposits up to the annual maximum.

Each state caps the total contribution amount a beneficiary can receive. Amounts vary, but the median cap for a 529 savings plan is $235,000. Contribution caps for 529 prepaid tuition accounts vary by plan, typically $50,000 to $100,000.

Account holder controls the money. The investors, such as the parents who open the account, control their money as long as the account is open, even after the student beneficiary turns 18.

Rollovers are allowed. Money invested in another 529 account, a custodial account, U.S. Savings Bonds, or Coverdell Education Savings Accounts can usually fund a 529 plan without incurring federal income tax.

Differences Between the Two Types of 529 Plans

Although each state plan is different, and the rules for each plan are constantly subject to change, here are some general differences between college savings and prepaid tuition plans.

  529 savings accounts 529 prepaid tuition accounts
Guaranteed returns (or not) Like most stock market investments, account earnings can fluctuate up or down. Some plans guarantee that earnings will at least match increases in in-state college tuition. The Private College 529 Plan issues "tuition certificates" guaranteed to cover percentages of future tuition.
Availability Accounts can typically be opened by anyone in any state with no age restriction. Some states offer special incentives to residents. State plans are typically open only to residents of that state. Not all states offer plans, and the number that do can change. More than 270 private colleges offer a prepaid national tuition plan (the Private College 529 Plan). Some age restrictions may apply.
Investment control Plans offer investment choices. Account holders can adjust investments once per year. Prepaid tuition plans offer no investment choices.
College choice limits The full amount in most accounts can be used at any private or public college in any state. State plans cover tuition for only in-state public colleges. Some plans allow students to transfer the funds to other schools, but these funds won't be sufficient to cover the higher cost of out-of-state or private tuition. The Private College 529 Plan certificates can be redeemed at any participating college.
Eligible expenses Most accounts can be used for any college-related costs, including tuition, room and board, fees, books, and required equipment. Most states allow students to use the accounts for tuition and fees only.
Pell Grant eligibility A high-performing account might disqualify students from a Pell Grant. If Pell-eligible beneficiaries can cover tuition from a prepaid plan, they would still qualify for the grant.

Transferring Money from Other College Savings Accounts to 529 Accounts

You can transfer money from certain tax-free college savings accounts into a 529 account without penalty. Assets from Coverdell Education Savings Accounts, Uniform Gift to Minors (UGTM) accounts, and certain types of U.S. savings bonds can generally be transferred tax-free. Each type of account comes with some caveats. Coverdell and UGTM money is held for the benefit of the student. If transferred to a 529 account, the money should be used for that student, not another beneficiary. As for bonds, only Series EE and Series I bonds issued after 1989 and held in a parent's name can be transferred.

Watch Out for Fees

Some 529 savings plans have higher administration fees than others, and these fees can eat into your earnings. These fees may have such names as program manager fee, age-based allocation option, guaranteed option fee, state oversight fee, trust oversight fee, brokerage fee, or asset-based fee. Many plans waive one or more of these fees, or they may combine two or more fees into one "management fee." Compare plans carefully before investing (collegesavings.org lists all the 529 plans by state).

If the Student Doesn't Need the Money

  • If the beneficiary decides not to attend college, account owners can typically transfer funds to anyone else in the beneficiary's family, including themselves, to use for qualified education expenses. For prepaid tuition accounts, refund options are also available.
  • If a scholarship covers some or all of the student's tuition and fees, the investor can usually withdraw the unused portion of a savings account without the tax penalty, up to the amount of the scholarship. The investor can also transfer prepaid tuition credits to another member of the family, hold them for possible future use, or request a refund on a semester-by-semester basis.

Note: Financial information provided on this site is of a general nature and may not apply to your situation. Contact a financial or tax advisor before acting on such information.

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