What is a 529 Plan?
A 529 plan is a tax-advantaged education savings account sponsored by states and educational institutions. The name comes from Section 529 of the Internal Revenue Code. The goal is to make it easier to save for a child's (or your own) future education with tax-free growth.
Key features
- After-tax contributions: no federal deduction, but many states offer a state income tax deduction or credit for contributions to their own 529
- Tax-free growth: investments inside the account grow without annual federal tax
- Tax-free qualified withdrawals: money used for qualified education expenses (tuition, room and board, books, required supplies, K-12 tuition up to an annual limit, certain apprenticeships, and some student loan payments) comes out free of federal tax
- High contribution limits: no federal annual cap, though large contributions may count against gift tax allowances. Lifetime limits are set by each state plan and typically exceed $400,000
- Owner keeps control: the account owner, not the beneficiary, decides when and how money is spent
- Beneficiary can be changed: if one child doesn't use the money, it can be transferred to another family member
Non-qualified withdrawals
If money is used for anything other than qualified education expenses, the earnings portion is subject to federal income tax plus a 10% penalty. A recent rule change allows unused 529 balances to be rolled into a Roth IRA for the beneficiary subject to limits and a 15-year account age requirement.
In-state vs. out-of-state plan
Most investors can use any state's 529 plan. The main reason to choose your home state's plan is the state tax deduction; otherwise, compare fees and investment options across plans. A few out-of-state plans have such low fees they often beat state-tax benefits elsewhere.