What is a 529 College Savings Plan?

By Ryan Repko, CFP®

Back to school season is a great time to think about opening a 529 College Savings Plan to fund future education expenses. A 529 College Savings Plan is a special type of savings account that allows investments to grow tax-free and withdrawals to be made tax-free for qualified college or trade school expenses.

These plans are provided by individual states and nearly every state has at least one; Illinois, for example, has two. The plan is sponsored by each state, but it does not have to be the state where the beneficiary attends school.

The plans are funded with after-tax dollars, and while contributions are not deductible on federal tax returns, they may be deductible on some state tax returns, like they are in Illinois. In a 529 savings plan, you can invest your contributions in a portfolio of mutual funds or similar investments. The account balance fluctuates with the performance of those investments.

In order to avoid taxes on the gains in the account, the proceeds must be used for “qualified education expenses.” These historically included tuition and fees, books, computer technology and equipment (including internet access), special needs equipment, and some room and board expenses. More recently, qualified education expenses were expanded to include federal tax exemption for K-12 expenses, apprentice program fees, and postsecondary credentialing expenses, however they still may be taxed by the state.

If the proceeds are not used for qualified education expenses, earnings on those proceeds will be subject to tax at your ordinary income tax rate plus a 10% penalty. There are exceptions, for example, if the beneficiary dies, becomes disabled, or receives a scholarship, the earnings avoid the 10% penalty but are still taxed as ordinary income. Additionally, a rule that took effect in 2024 allows up to $35,000 of a 529 plan to be rolled into a Roth IRA in the name of the 529 beneficiary.

529 plans are considered to be owned by the account opener, rather than the beneficiary of the account, which is usually a child or grandchild. A 529 plan can only have one beneficiary, so one must open multiple accounts if there are multiple people. That being said, the beneficiary of a 529 can be changed, so it may be possible to use the same 529 plan and switch beneficiaries over time.

529 plans provide some extra help when it comes to funding higher education, but the majority of the progress towards this goal will be based on advance planning and diligent saving. Savers should start early to give themselves extra years to save, and their investments extra time to compound and grow.

Ryan Repko is a Certified Financial Planner™ professional with Ruedi Wealth Management in Champaign, Illinois.