529 plan
Also called qualified tuition program, college savings plan
A state-sponsored savings plan for education where investment earnings grow tax-free when used for qualified education expenses.
What it means
A 529 plan, named for a section of the tax code, is an investment account for a beneficiary’s education. Contributions are not deductible on the federal return, but many states offer a state tax deduction or credit. Earnings grow untaxed, and withdrawals are tax-free when spent on qualified expenses such as college tuition, fees, books and room and board, with some K-12 and apprenticeship costs also allowed under federal rules.
If money is withdrawn for other purposes, the earnings portion is taxed as income and generally faces a 10% additional tax. The account owner can change the beneficiary to another family member, and under certain conditions some unused money can be rolled into a Roth IRA for the beneficiary. Plans and state tax benefits vary by state.
Example
Suppose parents deposit $10,000 and it grows to $25,000 by college. If all $25,000 pays for tuition, the $15,000 of earnings is never taxed. If instead it were withdrawn for a non-education purpose, the $15,000 of earnings would be taxed as income plus a $1,500 additional tax.
How it’s used
- Saving for a child’s or grandchild’s college
- Paying some K-12 private school tuition
- Reducing state income tax where a deduction is offered
Strengths and weaknesses
Strengths
- Tax-free growth for qualified education costs
- Possible state tax deduction or credit
- Owner keeps control and can change the beneficiary
- High total contribution capacity
Weaknesses
- Earnings used for non-qualified purposes are taxed and penalized
- Investment menus are limited to the plan’s options
- State tax benefits may be lost if moved to another state’s plan
Good to know
- A home state’s plan is not required, but it may be the only one that earns a state tax break.
See it in the data: College tuition relative to inflation →
Related terms
Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.