What is a 529 Plan?

Key facts

  • 529 plans are a tax-advantaged account for those saving for higher education expenses.
  • There are two types of 529 plans – the college savings program and the prepaid tuition program.
  • U.S citizens and resident aliens 18 years or older with a valid social security number or taxpayer identification number are eligible to open a 529 college savings program, and anyone can be a beneficiary of this plan.
  • 529 plans are managed by individual states and eligible investors can typically open a 529 account with any state.
  • 529 funds can be used for qualified educational expenses at any eligible institution nationwide or abroad.

Many families start thinking about college savings well before their children head off to college. After all, the cost of tuition keeps going up, and no one wants their children to start their adult lives saddled with student loans. Choosing the right savings plan that meets your circumstances and needs can seem complicated. However, there is one popular program that is specifically designed to simplify the process of college savings.

State-sponsored 529 plans, which are named after the section of IRS tax code that created them, offer tax incentives to encourage families to set funds aside for their children’s secondary education expenses. Though these plans are authorized at the federal level, each state offers its own version of the program. Families can typically participate in any state’s 529 plan, regardless of where they live, offering an opportunity to select the plan that best suits their needs.

The Benefits of a 529 Plan

In addition to the overall benefit of creating an account dedicated to your child’s college expenses, 529 plans come complete with federal tax advantages. For example, although your contributions are made with after-tax dollars, earnings grow federal tax-free in the account. As long as withdrawals are used for qualified educational expenses at an eligible institution, you will not pay additional federal taxes when you take distributions.

Many states also waive income taxes on 529 plan earnings, which increases the overall value of your account. While state tax benefits are typically only available for residents of the state sponsoring the 529 plan, at least six states offer state tax savings on contributions made to other states’ 529 plans. As you make your decision, take into account the potential tax benefits your state’s plan offers as well as the fees and investment selections offered by other states’ plans.

Some state plans offer additional incentives in an attempt to attract your business. For example, in 2015, approximately one third of state 529 programs offered some form of a contribution match. Eligibility for such grants varies. Sometimes, grants are limited to new accounts opened before the beneficiary’s first birthday, and other times, there are income guidelines that place restrictions on which participants will receive matching. Check the state-specific information for the plan you are considering for more details.

529 College Savings Plan vs. 529 Prepaid Tuition Plan

There are two types of 529 plans, and states are permitted to offer either, neither or both. In 2016, all 50 states and the District of Columbia offer at least one type of 529 plan. The college savings plan works like other types of saving and investment accounts: funds accumulate, and when the beneficiary is ready for college, you take a withdrawal to pay for education expenses.

Alternatively, a prepaid tuition plan allows you to pay for your child’s education in advance, with the added benefit of locking in the tuition rate in effect at the time you enroll. When the 529 prepaid tuition plan is opened, the price of each credit is fixed for the life of your account. The credits you purchase at today’s tuition rates can be applied to tuition expenses when your student is ready for college, regardless of how much the per-credit cost has increased since you enrolled in your 529 plan.

State prepaid tuition plans typically require students to attend an in-state public college or university, however there is a consortium of private schools that will accept credits purchased through a prepaid 529 plan.

This table compares the benefits of each option:

Plan features 529 College Savings Plan 529 Prepaid Tuition Plan
Tuition rates locked No lock on tuition rates Guarantees today’s tuition rates at participating colleges and universities
Qualified expenses Savings can be used for all qualified educational expenses, including tuition, room and board, books, required computers and mandatory fees at eligible colleges and universities Plan proceeds cover tuition and mandatory fees at participating colleges and universities only, as listed in the program’s enrollment documents
Contribution details Contribution limits are typically quite high, ranging from approximately $200,000 to $500,000 Plans are set up with installment payments, with the total amount divided by the age of the beneficiary
Guaranteed returns Savings are subject to standard investment risk and can lose value Most plans are guaranteed by the state
Age limit No age limit on eligibility Enrollment in most plans is limited by the beneficiary’s age or grade
Residency requirement Typically no residency requirement* Most plans have a state residency requirement
Enroll period Enrollment is open year round Most plans have a set enrollment period
Source: FINRA website

529 College Savings Plan Rules

There are two key participants in each 529 plan: the account owner and the account beneficiary. In some cases, these can be the same person. U.S. citizens and resident aliens 18 years or older with a valid social security number or taxpayer identification number can open an account, and there are no restrictions on who can benefit from the account. Of course, the most common account owners are parents and grandparents, and the most common beneficiaries are minor children and grandchildren.

Account owners act as custodian of the funds and they are able to make all investment decisions until the funds are withdrawn. Account beneficiaries are the individuals for whom the funds will be used. Each account can have only one beneficiary but the beneficiary can be changed to an eligible family member of the original beneficiary without incurring federal taxes or penalties. Since it can be difficult to know the exact amount needed for the college expenses that your student will incur in the future, 529 plans come with a helpful feature: excess funds can be rolled into another 529 account to benefit eligible family members, such as a sibling.

Many states place additional contribution limits on their plans. However, these are typically quite high, ranging from approximately $200,000 to $500,000. Note that taking distributions for reasons other than the beneficiary’s qualified educational expenses may result in standard tax liability for the plan’s earnings. In some cases, a 10% tax penalty may also apply.

Choosing a 529 College Savings Plan

Participants in 529 college savings plans are not limited to the specific program offered in their home state. Fees, investment options, and plan management vary dramatically from state to state, and some investors find that home-state tax incentives do not offset the losses incurred by high-fee plans that are poorly managed. Each year, investment research firms, such as Morningstar, rate state 529 plans, making it easier for families to choose the plan that offers them the greatest benefit. Funds withdrawn from a 529 plan can be used for qualified educational expenses at any eligible institution, including public or private college or university nationwide and even some abroad.


Nothing in this article should be construed as tax advice, a solicitation or offer, or recommendation, to buy or sell any security. This article is not intended as investment advice, and Wealthfront does not represent in any manner that the circumstances described herein will result in any particular outcome. Financial advisory services are only provided to investors who become Wealthfront clients.

This article is not intended as tax advice, and Wealthfront does not represent in any manner that the outcomes described herein will result in any particular tax consequence. Prospective investors should confer with their personal tax advisors regarding the tax consequences based on their particular circumstances. Wealthfront assumes no responsibility for the tax consequences to any investor of any transaction. Investors and their personal tax advisors are responsible for how the transactions in an account are reported to the IRS or any other taxing authority.

For information on any 529 college savings plan contact the plan provider for details on the investment objectives, risks, charges, expenses, and other important information included in the Plan Description and Participation Agreement; read and consider it carefully before investing.

Please Note: Before investing in any 529 plan, you should consider whether you or the beneficiary’s home state offers a 529 plan that provides its taxpayers with favorable state tax and other benefits that are only available through investment in the home state’s 529 plan. You also should consult your financial, tax, or other advisor to learn more about how state-based benefits (or any limitations) would apply to your specific circumstances. You also may wish to contact directly your home state’s 529 plan(s), or any other 529 plan, to learn more about those plans’ features, benefits and limitations. Keep in mind that state-based benefits should be one of many appropriately weighted factors to be considered when making an investment decision.

Earnings on nonqualified withdrawals are subject to federal income tax and may be subject to a 10 percent federal tax penalty, as well as state and local income taxes. The availability of tax and other benefits may be contingent on meeting other requirements.