Beginner's Guide to Section 529 Savings Accounts

Consider a Section 529 Plan for Your Child's College Fund

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Woman planning for her daughter's college. Photo: John Burke

Funding college is a top priority for many parents, grandparents, and others. A smart investment like a Section 529 savings plan can help build your assets to save more money for your child's college.

This beginner's guide will give you an overview of the advantages and disadvantages of a Section 529 plan, how they work, and who they usually make the most sense for. If you choose to open one, you may want to discuss the option further with your financial planner. They can give you details for your state and help you fit a 529 plan into your overall investment portfolio.

What Is a Section 529 Savings Plan?

Section 529 plans are so named after the specific IRS code that permits their use, section 529. A 529 plan may also be called a "qualified tuition program" or QTP. But whatever you call them, they're considered one of the best options for college savings because they offer substantial tax advantages.


There are two types of Section 529 plans: savings accounts, and prepaid tuition plans. This article specifically reviews Section 529 savings accounts.

Section 529 savings accounts allow you to make after-tax contributions on behalf of a designated beneficiary (not just a child). These contributions grow tax-deferred in your choice of investments and can be withdrawn tax-free for qualified educational expenses.

These expenses generally include tuition, fees, books, supplies, room, and board at an eligible educational institution, but may include other required expenses for attendance as well. Up to $10,000 can be used to fund elementary and secondary education.

Who Is the Ideal Investor for a Section 529 Savings Plan?

A Section 529 savings plan is ideal for parents or grandparents who have some combination of the following:

  • You would like to save more than $2,000 per year.
  • You make enough money to be disqualified from using a Coverdell ESA.
  • You want the freedom to reclaim the assets for any reason you choose.
  • You live in a state that offers a state income tax deduction for contributing to a Section 529 plan.
  • You have multiple children with the hope that all will attend college.
  • You start planning for college late in your children’s lives.
  • You are planning to save large amounts of money towards college costs.
  • Your children might attend expensive graduate programs.
  • You would like to fund a child's college while significantly reducing the size of your own estate.

Potential Advantages

Section 529 plans have a slew of advantages:

  • Tax-deferred growth and tax-free withdrawals: As long as the funds are used to pay qualified education expenses for the beneficiary, you won't have to pay taxes on the gains.
  • No income limits on contributors: Unlike other plans (such as the Coverdell ESA), the IRS doesn't impose income restrictions on contributors.
  • Effectively, no contribution limits: Contributions "can't be more than the amount necessary to provide for the qualified education expenses of the beneficiary."
  • Retain control of the assets: Section 529 allows a parent or donor to remain in control of the assets indefinitely. It even allows them to close the plan and get their money back (subject to taxes and penalties).
  • In-state income tax deductions: Donors are eligible for tax deductions and some credits in 34 states and Washington D.C.
  • Up to $10,000 to repay qualified student loans: Beneficiaries can apply up to $10,000 toward student loans.

Potential Disadvantages

While there are fewer downsides to the Section 529 plans than upsides, there are still some to be aware of. The biggest might be that distributions from Section 529 plans for pre-college expenses (grades K-12) are limited to $10,000.

But unlike investments you might hold in a regular brokerage account, you're not allowed to switch freely between investment options. In fact, you're only allowed to change your investments (like move from one mutual fund to another) twice per year or if there's a change in the beneficiary.

What Are Your Investment Options?

Section 529 savings plans have a preset menu of mutual fund investment choices. Most often, a state’s Section 529 plan will contract with a mutual fund company to manage the plan. In turn, this company’s mutual funds will be the extent of available investment choices.

Many of the Section 529 savings plans offer “age-based” investment options, which allocate your investment between stock, bond, and money market funds based on your child’s age. As they get older, the fund becomes more conservative in its investment mix.

You are permitted to change your investment strategy twice per calendar year. Exceptions are made if you move your assets from one state’s plan to another or name a new beneficiary.

What Are the Tax Benefits?

The biggest tax benefit of the Section 529 plan is that it allows for tax-deferred accumulation and tax-free withdrawals for qualified expenses. In other words, you do not have to pay tax on any of the annual growth of your original investment if the money is used for qualified education purposes.


There is no federal tax deduction for putting money into a Section 529 plan. Contributions are made with “after-tax” dollars and will not lower what you owe the IRS.

However, 34 states and the District of Columbia offer an income tax deduction to their residents for funding a Section 529 plan. Typically, this deduction is only available if you use your state’s plan.

Additionally, Section 529 plans may allow for advanced estate tax planning strategies for families trying to avoid inheritance taxes.

What Are the Eligible Expenses?

An account owner may initiate a tax-free distribution on behalf of the beneficiary for “qualified” college or graduate school expenses (in most states). Unlike the Coverdell ESA, qualified expenses for elementary and secondary education (K-12) are limited in Section 529 plans to $10,000.

The IRS rules for Section 529 qualified higher education expenses, while still being fairly liberal, are more strict than the Coverdell. Covered expenses include:

  • Tuition
  • Room and board (student must be enrolled at least half-time)
  • Computers or laptops (only if the school requires them)
  • Books and supplies (as required by the university)

How Does Section 529 Impact Federal Financial Aid Eligibility?

Section 529 savings accounts have a minimal effect on federal financial aid, as they are generally considered an asset of the parent. If owned by the student, they'll have a greater impact on aid, but still less than the student's income would.

If the owner is a grandparent, a member of the extended family, or an unrelated individual, it is argued that the assets do not count against financial aid at all. This is because there is no place to report assets owned by people other than a parent or student on the FAFSA form.

However, students are required to report any distributions as unearned income if received from a 529 plan owned by someone other than themselves or their parents or legal guardian. Since the student's income is considered at a higher rate when calculating the expected family contribution (EFC), it could reduce the amount of aid they qualify for.


Section 529 savings plans have the most flexible eligibility rules of any college savings vehicle. In essence, anyone can open and contribute to a Section 529 plan on behalf of anyone else, without regard to the age, income, or relationship of either party.

Contribution Rules

The only official limit placed on contribution amounts is a “lifetime limit” per recipient, which is set by each individual state. This limit is meant to keep individuals from dramatically over-funding college savings account beyond what is realistically needed. This lifetime limit generally exceeds $250,000 in most states and varies from state to state.Otherwise, individual plans may have limits as well.

Additionally, contributors need to be aware of gift tax rules regarding larger contributions. Normally, a gift of over $16,000 to anyone besides your spouse will require you to file a gift tax return for that year.

Within Section 529 plans, there is a special provision that allows individuals to make five years’ worth of contributions into the plan in one year for one beneficiary, without owing gift tax on the amount.

  • A gift of this amount requires a special election to be made on a IRS Form 709 in the year of the initial gift.
  • Any additional gifts to that person in the following five years, even if not into the Section 529 plan, will likely trigger a gift tax on the excess amount.

Withdrawal Rules

There are no taxes or penalties on withdrawals made to fund educational expenses, as long as the withdrawal doesn’t exceed the actual amount of qualified expenses. If excess funds are withdrawn, a portion will be subject to taxation and a 10% penalty (this may be waived in certain cases).

Treatment of Unused Funds

There are no rules or age limits on when Section 529 funds have to be used. If there is no longer a need for a Section 529 plan for an individual, you can change the beneficiary. This includes immediate family members of the original beneficiary, parents, cousins, aunts, and uncles, and in-laws.

But you or the beneficiary may want to let the account grow and use it for other purposes. You'll face taxes and a 10% penalty if not spent toward qualified education expenses, but the years of tax-deferral could more than make up for that.

Frequently Asked Questions (FAQs)

Is there a contribution deadline for 529 plans?

No, you can make contributions at any time. However, you should consider gift tax rules to make sure you're not exceeding your annual gift tax exclusion. If you want to make a large contribution, consider using the special provision that allows you to contribute five times the annual gift tax exclusion amount without penalty. Talk to a CPA for provision specifics and to make sure the move makes sense for you.

What happens if my child doesn't go to college?

If your child doesn't need the account, you can swap the beneficiary for an immediate family member of theirs who does. Or, you can let the funds continue to grow and use them for whatever you want. Just keep in mind that you'll face taxes plus a 10% penalty tax if the money isn't used to fund qualified education expenses for the beneficiary.

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  1. Cornell Law School, Legal Information Institute. "26 U.S. Code § 529 - Qualified Tuition Programs."

  2. IRS. "Publication 970, Tax Benefits for Education (2020)," Pages 51-52.

  3. IRS. "Publication 970, Tax Benefits for Education (2021)," Page 41.

  4. IRS. "Publication 970, Tax Benefits for Education (2021)," Page 54.

  5. IRS. "Tax Benefits for Education," Page 52.

  6. IRS. "Tax Benefits for Education," Pages 52-54.

  7. BlackRock. "Take Advantage of Your State Tax Benefits."

  8. "Investor Bulletin: An Introduction to 529 Plans."

  9. IRS. "Topic No. 313 Qualified Tuition Programs (QTPs)."

  10. IRS. "Tax Benefits for Education," Pages 51-52.

  11. FSA Partner Connect. "The EFC Formula, 2021–2022," Page 29. See "Table 8: Contribution from AAI."

  12. FSA Partner Connect. "The EFC Formula, 2021–2022," Page 9. See "2021–2022 EFC Formula A: Dependent Student."

  13. Federal Student Aid. "2021-2022 Free Application for Federal Student Aid," Page 6, 9.

  14. Finra. "529 Savings Plans."

  15. IRS. "What's New - Estate and Gift Tax."

  16. IRS. "2021 Instructions for Form 709," Page 7.

  17. IRS. "Tax Benefits for Education," Page 52-54.

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