How a 529 Plan Works and What It Costs You

A 529 plan is a tax-advantaged savings account that lets you set aside money for education expenses without paying federal income tax on the growth

You open an account, contribute after-tax dollars, and the money grows tax-free as long as you use it for may have access to education expenses. Those expenses include tuition, fees, room and board at an accredited college or university, as well as K-12 tuition and up to $35,000 in student loan repayment. The federal tax benefit is real: if you invest $10,000 and it grows to $15,000, you owe no federal tax on that $5,000 gain when you withdraw it for school.

Each state runs its own 529 program, and you can open an account in any state regardless of where you live or where your child will attend school. The account owner (usually a parent) controls the money and decides when to withdraw it. Your child does not own the account, which matters if they later need financial aid — the account counts as a parental asset, not a student asset, and reduces aid may be able to access less severely than a student-owned account would.

Key Takeaways

• Money in a 529 grows tax-free federally, and you pay no tax on withdrawals used for tuition, fees, room and board, K-12 tuition, or student loan repayment up to $35,000 lifetime.
• You contribute after-tax dollars, but many states offer a state income tax deduction for contributions, which means you get money back on your state taxes.
• If you withdraw money for something other than education, you owe federal income tax plus a 10 percent penalty on the earnings portion only — the money you contributed comes out tax-free.
• Each state's 529 program has different investment options and fee structures, so comparing programs can save you hundreds of dollars over time.
• You can change the beneficiary to another family member without penalty, which gives you flexibility if your first child does not attend college or if you have other children.

How contributions and tax deductions work

You can contribute as much as you want to a 529 in a given year, but the IRS sets an annual gift tax exclusion limit. For 2024, you can give up to $18,000 per person per year without filing a gift tax return. Married couples can give $36,000 per child. If you give more than that, you file a form but still owe no tax — you are just using part of your lifetime gift tax exemption.

The real tax benefit for most families comes from your state, not the federal government. Most states let you deduct 529 contributions from your state taxable income. New York allows up to $10,000 per beneficiary per year. Illinois allows unlimited deductions. Some states, like Texas and Florida, offer no state deduction at all. If your state offers a deduction, you get the benefit on your state tax return the year you contribute — you might owe less state tax or get a larger refund.

A few states limit the deduction to contributions made to their own 529 program. Most states let you deduct contributions to any state's program. Before you open an account, check whether your state offers a deduction and whether it applies only to your state's plan or to any plan.

What counts as a may have access to education expense

Withdrawals are tax-free when used for tuition and mandatory fees at any accredited college, university, or vocational school. Room and board counts if the student is enrolled at least half-time. Books, supplies, and equipment required by the school count. A computer or internet access counts if the school requires it.

K-12 tuition at public, private, or religious schools is now a may have access to expense, up to $35,000 per student over their lifetime. Student loan repayment — your own loans or your child's loans — is also may have access to, up to $35,000 lifetime per person. The $35,000 limit applies to each person separately, so if you have two children, each can receive $35,000 in loan repayment.

Room and board at a college does not include a meal plan purchased separately from the school; it must be part of the school's standard charges. Tuition at a school that is not accredited does not count. Transportation, insurance, and personal expenses do not count, even if your child needs them while in school.

Penalties and taxes on non-may have access to withdrawals

If you withdraw money and do not use it for a may have access to expense, you owe federal income tax on the earnings portion of the withdrawal, plus a 10 percent penalty on those earnings. The contribution portion comes out tax-free — only the growth is taxed and penalized.

Example: You contribute $20,000 over five years. The account grows to $28,000. You withdraw $8,000 for a non-may have access to expense. The $8,000 consists of $5,714 in contributions (which come out tax-free) and $2,286 in earnings. You owe federal income tax on the $2,286 at your ordinary income tax rate, plus a 10 percent penalty ($228.60). Your state may also tax the earnings and penalty.

The penalty does not apply if the beneficiary receives a scholarship. If your child gets a full scholarship, you can withdraw an amount equal to the scholarship without penalty, though you still owe tax on the earnings portion of that withdrawal. The penalty also does not apply if the beneficiary dies or becomes disabled, as defined by the IRS.

Changing beneficiaries and rolling money between accounts

You can change the beneficiary to another family member without triggering the penalty. Family members include your child's siblings, cousins, aunts, uncles, grandparents, and in-laws. You can also change the beneficiary to yourself if you want to use the money for your own education. This flexibility means you are not locked in if your first child does not attend college or if you have other children who will.

You can also roll money from one 529 to another without penalty. If you opened an account in your state's plan but found a plan with lower fees or better investment options, you can move the money. The IRS allows one rollover per beneficiary per 12-month period, and the money must go to an account for the same beneficiary or a family member.

As of 2024, you can also roll unused 529 money into a Roth IRA for the beneficiary, subject to limits. The account must have been open for at least 15 years, and you can roll up to $35,000 lifetime per beneficiary. This rule is new and the details are still being finalized by the IRS, so check with your plan administrator before relying on it.

Comparing 529 plans: fees and investment options

Each state offers its own 529 program, and the costs vary widely. Some plans charge an annual account maintenance fee of $25 to $50. Investment options usually include age-based portfolios (which automatically shift from stocks to bonds as your child gets closer to college) and individual fund options (where you choose how to invest). Each investment option has an expense ratio — the annual cost to hold that fund, expressed as a percentage of your balance.

A low-cost plan might charge 0.15 percent annually in expense ratios on an age-based portfolio. A high-cost plan might charge 1.0 percent or more. On a $50,000 account, that difference is $425 per year. Over 15 years, the difference compounds significantly. Before opening an account, compare the expense ratios and account fees of your state's plan and at least one other state's plan.

Some states offer direct-sold plans (you open the account yourself online) and advisor-sold plans (you work with a financial advisor who takes a commission). Direct-sold plans almost always have lower fees. If you are comfortable choosing investments on your own, a direct-sold plan saves money.

How a 529 affects financial aid

A 529 account owned by a parent counts as a parental asset on the Free Application for Federal Student Aid (FAFSA). Parental assets reduce aid may be able to access by up to 5.64 percent of the account balance per year. A $50,000 account might reduce your child's aid by roughly $2,820 per year.

A 529 owned by a grandparent or other non-parent does not appear on the FAFSA at all, which is why some families use grandparent-owned accounts. However, when the student withdraws money from a grandparent-owned account to pay for school, that withdrawal counts as student income on the next year's FAFSA and reduces aid by up to 50 percent of the withdrawal amount. The timing of withdrawals matters if your child will receive need-based aid in multiple years.

A 529 does not affect merit aid (scholarships based on grades or test scores). It only affects need-based aid calculated from the FAFSA.

Frequently Asked Questions

Can I use a 529 for graduate school?

Yes. Tuition and fees at graduate programs count as may have access to expenses. Room and board counts if the student is enrolled at least half-time. Graduate school loans can also be repaid with 529 money, subject to the $35,000 lifetime limit.

What happens if my child gets a full scholarship?

You can withdraw an amount equal to the scholarship without the 10 percent penalty. You still owe federal income tax on the earnings portion of that withdrawal, but not the penalty. The contribution portion comes out tax-free.

Can I open a 529 for a grandchild?

Yes. You can open an account for any family member, including grandchildren. A grandparent-owned account does not appear on the FAFSA, but withdrawals count as student income on the following year's aid calculation, which can reduce aid may be able to access.

What if I want to use the money for trade school or community college?

Both count. Any accredited post-secondary school qualifies, including community colleges, vocational schools, and certificate programs. Tuition, fees, books, and required equipment all count as may have access to expenses.

Can I move money between 529 plans?

Yes, you can roll money from one plan to another without penalty. The IRS allows one rollover per beneficiary per 12-month period. The money must go to an account for the same beneficiary or a family member. Check your plan's rules before initiating a transfer.