Every parent dreams of sending his or her child to college - but making this dream a reality can often feel like an insurmountable task. The average cost of tuition in the U.S. continues to rise, according to a 2024 report from the College Board, and attending college could set your child back tens of thousands of dollars annually.
Average Tuition for Four-Year Colleges
Fortunately, you have options as a parent. A 529 college savings plan, for example, could help you sock away money for your child's future higher education expenses. Explore the basics of 529 plans, learn how such plans could be used and discover if one could be the right choice for your family.
Understanding a 529 College Savings Plan
A 529 plan is a tax-advantaged investment account designed to help families save for education costs. These plans are sponsored by states, state agencies, or educational institutions and can be opened on behalf of a beneficiary (such as your child).
How It Works
You contribute money to the account, where the funds are invested and have the potential to grow over time, though they may also lose value. When it comes time to pay for education, you can withdraw the funds to cover qualified educational expenses at accredited institutions. Throughout the process, earnings grow tax-deferred, and withdrawals used for qualified expenses are generally free from federal and state income taxes.
Who Can Open a 529 Plan?
- Parents
- Grandparents
- Aunts
- Uncles
- Cousins
- Non-relatives
These accounts are flexible, allowing you to transfer them to another qualified family member of the beneficiary if needed. Additionally, there’s no limit to the number of 529 plans a person can open.
Contribution Rules
Maximum contributions vary by plan. States set their own limits (often above $300,000). While the IRS doesn’t impose a strict cap, federal gift tax rules may apply if contributions exceed annual gifting limits.2 For specifics, check your plan’s program description.
Tax Benefits & Penalties
529 plans offer several tax advantages:
- Contributions may or may not be tax-deductible depending on your state.
- Money grows tax-deferred.
- Withdrawals for qualified expenses (tuition, fees, books, some room and board) are generally tax-free.
If funds are used for non-qualified expenses, you may face:
- A 10% federal tax penalty on earnings.4
- Ordinary income tax on any gains.
Prepaid Tuition vs. College Savings
There are two main types of 529 plans: Prepaid Tuition Plans and College Savings Plans. Both can help pay for future education, but they work differently.
Prepaid Tuition Plans
With tuition credit plans, you purchase credits at participating colleges and universities, locking in today’s tuition rates for future use. This approach helps protect against rising tuition costs because the value of the credits stays tied to tuition over time. For example, if you buy credits equal to two-thirds of the current in-state tuition, those credits should still cover two-thirds of tuition when they are used years later.
Limitations
- Usually cannot be used for room and board.
- Often limited to public or in-state schools, not private or out-of-state options.
- The student (beneficiary) may need to be a state resident.
- If the student doesn’t attend a participating school, the payout may be less than contributions.
College Savings Plans
These accounts work by investing money in portfolios, often made up of mutual funds or ETFs. Over time, the account can grow in a tax-advantaged way, and the funds can later be withdrawn to help cover qualified education expenses.
Flexibility
- Usable at any accredited college or university in the U.S. (and some abroad).
- Covers a wider range of costs, including tuition, fees, books, and often room and board.
Investments in these accounts are subject to market fluctuations, meaning balances can rise or fall over time. Additionally, if funds are withdrawn for non-qualified expenses, taxes and penalties may apply.
Quick Comparison
| Feature | Prepaid Tuition Plans | College Savings Plans |
|---|---|---|
| Covers Tuition | Yes | Yes |
| Covers Room & Board | No | Yes (if qualified) |
| School Options | Mostly in-state, public | Any accredited college/university |
| Investment Growth | No (tuition locked at current rates) | Yes, but tied to market performance |
| Risk | Lower (fixed tuition credits) | Higher (market risk) |
| Residency Requirement | Often required | Usually not required |
How Can the Money Be Spent?
A 529 college savings plan can only be used for qualified education expenses. These are costs directly tied to a student’s education.
Qualified expenses include:
- Tuition and fees
- Books, supplies, and required equipment
- Room and board (for students enrolled at least half-time)
- Computers, software, and internet access (if required for schoolwork)
- Certain K–12 tuition expenses (up to $10,000 per year, depending on the plan)
Expenses that do not qualify include:
- Food and meal plans beyond approved room and board
- Cellphone payments or service plans
- Clothing or personal items
- Entertainment (concerts, movies, streaming services)
- Transportation or travel costs
Using funds for non-qualified expenses could result in taxes and penalties, so it’s important to plan carefully.
Conclusion
Deciding whether a 529 plan is the right choice comes down to your family’s unique needs. Think about your financial situation today, the amount of time you have to save before your child begins school, and whether you’d like flexibility to use the funds for K–12 or higher education costs. By clearly understanding what expenses a 529 plan covers - and what it does not - you’ll be better prepared to determine if this type of savings account aligns with your long-term education goals.
A 529 plan offers tax-free growth to help you fund future education expenses. Invest Today
Sources
- Trends in College Pricing: Highlights. https://research.collegeboard.org/trends/college-pricing/highlights.
- Tax Benefits for Education 2024. https://www.irs.gov/pub/irs-pdf/p970.pdf.
- 529 State Comparison. https://www.collegesavings.org/find-my-states-529-plan.
- H.R.1 - An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018. https://www.congress.gov/bill/115th-congress/house-bill/1/text.
