529 College Savings Plan: Why Parents Need One and How to Get Started

December 21, 2023

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As a parent, there’s a good chance that you’ve already heard the jaw-dropping estimate that it costs over $200,000 to raise a child. What might drop your jaw even further is the fact that this estimate has nothing to do with post-graduation life. If you plan to help your child pay for college, a 529 college savings plan might be exactly what you need to start smiling about your finances again.

Let’s explore exactly what a 529 college savings plan is. Then, let's dive into the ways that many families can use this savings tool to their benefit.

If this financial tool is right for you, you can even take the first step to making college more affordable today. 

What is a 529 College Savings Plan?

Simply put, a 529 college savings plan is a tool that is used to pay for higher education. Its name comes from the portion of the Internal Revenue Service code that details how the plan works.

You don't need to take a deep dive into the tax code to understand the basics of a 529. Essentially, money deposited into a 529 college savings plan grows tax-free. When the money is withdrawn, it is tax-free and penalty-free as long as it is used for a qualified education expense. 

Anyone can open a 529 college savings plan. However, it is more likely that the plan will be opened by parents, grandparents, or other relatives. 

What a 529 Can Be Used For

The money in a 529 college savings plan can be withdrawn without penalties and taxes to pay for qualified higher education expenses. 

Some of these expenses include:

  • Tuition and other fees
  • Room and board
  • Books and supplies
  • Computers and related equipment 
  • Repayment of a portion of student loans 

You will want to make sure to keep your receipts as you make these purchases. Also, purchasing qualified expenses separate from other expenses can make your record keeping clearer. 

Tuition includes colleges, universities, and vocational schools. It also includes certain postsecondary schools that participate in student aid programs from the US Department of Education.

While it was originally designed to pay for higher education, a 529 college savings plan can also be used for K-12 expenses in some instances thanks to the 2017 Tax Cuts and Jobs Act.

The plan can also be used for apprenticeships as of 2019 with the passage of the SECURE Act. 

Who Can Contribute to a 529 College Savings Plan

Do you always find yourself stumped when family and friends ask what to get your child for their birthday or an upcoming holiday? Consider having them make a contribution to a 529 instead!

529 plans are designed to allow third-party contributions. Contributors do not have to be beneficiaries or even members of the family to contribute. That means that next Christmas, you might suggest one less LEGO set and give Grandma or Grandpa the link to make a contribution to college instead. 

Worried that your family and friends aren’t tech-savvy? No problem! Most 529 college savings plans also accept checks. After you set up your specific plan (more on that in a bit!), you can explore specific details about third-party contributions.

Why Do I Need a 529?

Parents and Baby
Photo by Jakob Owens on Unsplash

In short, you need a 529 to make college more affordable. Giving your child a head start with the cost of education is one way to build generational wealth. While there are other ways to save on college costs, planning ahead using a 529 can help ease some of that financial stress. In addition to allowing compound interest to work in your family's favor, there are other benefits to having a 529 college savings plan.

These plans offer unique tax benefits, can be an opportunity for other people to help your child, and are surprisingly flexible–despite what you may have heard!

529 College Savings Plans Have Tax Superpowers 

One of the biggest perks about 529 college savings plans has to do with how your money grows. Contributors fund the account with post tax dollars.

Since taxes have already been paid on the money, the savings grows tax-free. When the money is withdrawn for qualified educational expenses, it is not taxed either. That’s a serious tax advantage over many other savings and investment vehicles. 

Help Others Help You

But maybe you aren’t in a position to help your child with the cost of college. Even if you don’t personally plan to set money aside for college savings for your child, other family members and friends can use a 529 plan to do so. 

Additionally, some state plans offer specific grant programs and other financial support to families participating in their 529 plans. In the state of Colorado, their grant matching program allows lower and middle-income families to qualify for a grant that matches 529 contributions up to $500 a year for five years. 

Some states also offer an employer 529 matching program that can also help with college savings.

The Surprising Flexibility of a 529

Many people also worry that they may have too much money in a 529. However, there are some features of 529 college savings plans that make them surprisingly flexible. The first thing to note is that if your child earns a scholarship, the amount of that scholarship can be withdrawn from the 529 penalty free.

Additionally, you can also change the beneficiary on a 529 plan. That means that if one child doesn’t go to college, you could put the savings in another child’s name by rolling money into their 529 account. You could also simply change the beneficiary on the current plan. You also have the option of using the money for yourself if going back to school is on your bucket list or might boost your salary. 

Moving Your 529 to a Roth IRA

We thought 529 college savings plans were great to begin with. They're about to get even better thanks to some new flexibility that goes into effect in 2024.

You will be able to convert 529 funds to a Roth IRA. How sweet is that?

Of course, there are some stipulations:

  • The conversion is capped at $35,000.
  • Your account has to be open for 15 years or more.
  • The beneficiary of the 529 becomes the account holder of the Roth IRA.

If you follow these stipulations, the money moves tax-free and penalty-free. These changes are part of the SECURE 2.0 Act of 2022, and they definitely address some of the concerns people had about 529 plans.

How to Start Investing Today

happy kids
Photo by Nathan Dumlao on Unsplash

One of the most important things to remember about investing in a 529 college savings plan is that it is important to start as soon as possible. The sooner you begin to invest, the more time compounding has to work in your favor. 

529 plans are run by individual states, and their rules differ. The majority of people who invest in 529 plans currently choose to invest in their own state plan, according to an Investment Company Institute study. However, you want to consider the possibility of tax deductions and fees before choosing a plan. 

Explore Possible Tax Deductions

529 college savings plans are a unique investment vehicle in that they benefit different people in different ways. All 529 plans are funded with post-tax dollars. That means that you’ve already paid taxes on the money you invest. But depending on where you live, you might be able to enjoy a tax benefit.

Currently, 32 states allow for a state income tax deduction based on your contribution. A handful of states allow you to deduct the full amount you contribute each year. However, other states will only allow you to deduct part of the contributions. Regardless, if you have the opportunity to lower your state income tax obligation, it might be wise to take it.

Comparing plans by state will help you determine specifics about each plan, including possible tax deductions.

Consider Fees

Another key consideration to make before you start investing is to explore the fees associated with various accounts. Generally, the lower the fees, the better. Why? You keep more of your money! The higher your 529 college savings plan expense ratio, the more that fees eat into your returns.

For instance, let's start with a $15,000 investment. If this investment earns a 6% return with a 1.5% fee, it is worth $23,294.54 in ten years. However, if you invest the same amount of money into a fund that only charges 0.5%, your investment is worth $25,622.17 in the same ten years time. That’s a difference of over $2,000! 

While you might be tempted to invest in your own state’s 529 college savings plan, you can actually choose any state’s plan. By keeping a careful eye on fees, you can send your kiddo off to college with more cash. It might seem confusing to choose a different state’s plan, especially if your state offers a tax deduction. However, some state plans are so fee-laden that they actually cancel out any financial benefit.

Even after you choose a state plan, you want to select your fund carefully. Look at the past performance of the fund. More importantly, pay close attention to other details, especially the expense ratio. 

Final Thoughts on 529 College Savings Plan

A 529 college savings plan definitely isn’t for everyone. However, many families that find themselves in a position to try to cover some or all of their child’s college cost find that this investment vehicle can make the cost of college much more attainable. It can also be a great gift idea for friends and family as your child grows up!

Check out the College Savings Plans Network to explore which plan might best fit your family's needs.

Does a 529 college savings plan seem like it might work for your family?

Please let us know in the comments below.

Andy Hill

Andy Hill, AFC® is the award-winning family finance coach behind Marriage Kids and Money - a platform dedicated to helping families build wealth and happiness. With millions of podcast downloads and video views, Andy’s message of family financial empowerment has resonated with listeners, readers and viewers across the world. When he's not "talking money", Andy enjoys being a Soccer Dad, singing karaoke with his wife and relaxing on his hammock.

One Comment

  • It just depends. We knew we had bright kids and that even with millionaire parents they might qualify for merit based scholarships. Plus we could cash flow three kids in college, the math worked fine since we were limiting our costs to four years at an in state university for a major that had real job prospects. Liberal arts highly discouraged. Years later our two engineers and one business major all got out with totally free four year college degrees including the extra stuff like fees, books and room and board. They all had zero debt and money in the bank. They also all elected graduate school and we wished them good luck with that, but did not give them any money. Now they all have multiple degrees and good jobs and have been totally off our payroll for years. I know that there are ways to get money out of 529’s that is offset by scholarships but we avoided the complexity by just not going that route. I would not recommend following our path unless you are high earners with academically advanced kids and can prove to yourself that you can cash flow college for them. Or of course if you think parents should make their kids fend for themselves after the age of 18, there is a lot to be said for that, but it wasn’t what we chose.


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