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INVESTING 529 College Savings Plan: How It Works and Whether Y... 2026-02-27 · 5 min read · 529 plan · college savings · education fund

529 College Savings Plan: How It Works and Whether You Should Use One

investing 2026-02-27 · 5 min read 529 plan college savings education fund tax-free growth 529 vs Roth IRA

College costs have risen dramatically over the past few decades — the average in-state public university now runs $27,000+ per year when you include room and board. A 529 savings plan is one of the most powerful tools for families saving for college, offering tax-free growth on money invested for education expenses. Here's how they work.

What Is a 529 Plan?

A 529 plan is a tax-advantaged savings account designed specifically for education expenses. Named after Section 529 of the Internal Revenue Code, these accounts are sponsored by states and managed by financial institutions.

Money you contribute to a 529 grows tax-free, and withdrawals are also tax-free when used for qualified education expenses. That's a significant tax advantage — if your money doubles in 10 years, you owe zero taxes on those gains.

What Qualifies as a 529 Expense?

College and university expenses:

K-12 education (up to $10,000/year): The 2017 Tax Cuts and Jobs Act expanded 529s to cover K-12 private school tuition.

Student loan repayment: You can withdraw up to $10,000 (lifetime limit per beneficiary) to repay student loans.

Vocational and trade schools: Many trade and certificate programs qualify.

What doesn't qualify: Extracurricular activities, transportation, health insurance, sports equipment not required for coursework.

How 529 Taxes Work

Federal tax treatment: Contributions are made with after-tax dollars (no federal deduction). Earnings grow tax-free. Qualified withdrawals are tax-free.

State tax deductions: 34 states plus DC offer a state income tax deduction or credit for 529 contributions. This is often the best reason to use your own state's plan — you might deduct $5,000-$20,000 per year in contributions from your state taxes.

Non-qualified withdrawals: If you withdraw for non-education purposes, you'll owe income taxes plus a 10% penalty on the earnings portion. The principal (what you contributed) comes back to you tax-free.

Contribution Limits

There's no annual contribution limit for 529s — you can contribute as much as you want. However:

Gift tax: Contributions are treated as gifts. The 2026 annual gift tax exclusion is $18,000 per donor per beneficiary. You can superfund a 529 — contribute up to $90,000 at once (5 years of gifts) without gift tax consequences, though you can't make additional gifts to that beneficiary for 5 years.

Account balance limits: States cap total balances, typically at $300,000-$500,000 per beneficiary. Once the account reaches that limit, you can't make additional contributions (but the money can continue to grow).

Investment Options

529 plans typically offer mutual funds and ETFs organized into portfolios. The most common:

Age-based portfolios: Automatically shift from aggressive (mostly stocks) to conservative (mostly bonds) as your child approaches college age. The most hands-off option.

Static portfolios: You choose the allocation and it stays fixed. Useful if you want more control.

Individual fund options: Some plans let you build your own allocation from available funds.

Quality varies by state plan. Some plans (Utah, Nevada, New York, California) have excellent low-cost fund options. Others have mediocre funds with high fees. You can use any state's plan regardless of where you live.

Choosing a 529 Plan

Start with your own state: If your state offers a tax deduction for contributions, often use your state's plan even if it's not the "best." A $3,000 state tax deduction at a 5% state tax rate saves $150/year — that beats small differences in fund expense ratios.

If no state deduction (or living in a state with no income tax): Shop for the best plan. Top-rated plans by low costs and investment quality:

Avoid: Plans with high advisor fees or loads (front-end fees), plans with limited fund choices, or plans where expense ratios consistently exceed 0.5%.

What If My Child Doesn't Go to College?

This concern stops many families from opening a 529, but your money isn't trapped.

Change the beneficiary: You can change the beneficiary to any family member — siblings, cousins, your spouse, even yourself. There's no tax event when you do this.

Roth IRA rollover (new in 2024): The SECURE 2.0 Act allows rolling over 529 funds into a Roth IRA for the beneficiary, subject to conditions:

This makes 529s much more flexible — if your child earns a scholarship or doesn't attend college, the money can still become a tax-free retirement nest egg.

Non-qualified withdrawal: You'll owe income taxes + 10% penalty on earnings. This isn't great, but if the account has grown significantly, you might still come out ahead versus a taxable account.

529 vs Roth IRA for Education Savings

Some financial advisors suggest using a Roth IRA as a college savings vehicle instead of a 529. Here's the tradeoff:

529 advantages:

Roth IRA advantages:

The practical recommendation: If you're behind on retirement savings, prioritize retirement accounts first. If retirement is on track, 529s are excellent for education savings — especially in states with generous tax deductions.

How to Open a 529

  1. Check your state's plan first — search "[your state] 529 plan" to find the official plan
  2. Compare it to top-rated plans if your state doesn't offer a tax deduction
  3. Open online — most state 529 plans allow direct account opening in 15-30 minutes
  4. Choose an age-based portfolio unless you want to manage allocation yourself
  5. Set up automatic monthly contributions — even $50-$100/month compounds significantly over 18 years
  6. List a contingent beneficiary in case anything happens to your child

How Much Should You Save?

A rough target: aim to save for about one-third of projected college costs. The student can fund a third through work and loans, and the final third comes from current cash flow.

For a child born today saving for 18 years at 7% growth:

Start early — the first years of compounding matter most. Even $50/month started at birth grows to a meaningful amount by age 18.

The 529 is one of the most powerful college savings tools available. If you have children, or expect to someday, starting one early pays off significantly.