What Is a 529?

It’s no secret that college is expensive. In fact, the total cost of attending college is now $35,720 per student annually. For a 4-year degree, that’s an incredible $142,880. This figure includes total costs, including tuition, books, room and board, etc. 

Many students now rely on student loans, unless they are fortunate enough to have college funds from their loved ones. If a college fund is set up and contributed to regularly, it can make a huge dent in the cost of pursuing higher education. 

For parents and loved ones of young children, it pays to plan ahead when it comes to saving for college. It’s also wise to take advantage of any tax-advantaged accounts that are available, such as a 529 account. 

But what is a 529 plan, exactly? This article will tell you everything you need to know about this popular tax-advantaged account. 

What is a 529? 

A 529 account is a type of savings and investing account designed to help people save for college. Anyone over 18 can open a 529, but the accounts are most often opened by parents and other family members, on behalf of young children. 

529 accounts have a beneficiary, which is the person who will be able to utilize the money in the future. For example, a parent could open a 529 with their newborn baby as the beneficiary — or an uncle could open one for his niece. 

The person who opens the account maintains control of the account forever, however. Unlike a custodial account, the assets don’t automatically transfer to the beneficiary once they turn 18. The account owner can decide how and when to utilize the money, and can even change the beneficiary in some cases. 

Once the account is set up, anyone can contribute money to the 529. Funds can be invested in a number of ways and can grow tax-deferred (meaning there is no income tax as long as the money stays in the account). 

When funds are withdrawn, they’re tax-free as long as they are used for qualifying educational purposes. 

You can open a 529 account at most major brokerages and financial institutions, and you can usually invest the funds in a variety of asset classes. 

529 accounts can also have state-level tax benefits. 529 plans are sponsored by each state, and the rules vary in every US state. You’ll want to look into the 529 plan specifics in your home state to get all the details. 

What can 529 funds be used for?

What is a 529 good for? Technically, 529 money can be withdrawn and used for any purpose. However, the tax benefits only kick in if the money is used for qualifying educational expenses, such as:

• College tuition

• K-12 tuition

• Certain apprenticeship costs

• Student loan repayments

If funds are used for a qualifying educational purpose, no income tax will be due on the earnings of the account.

If funds are used for any other purpose, income tax is owed on the profits. Plus, a 10% tax penalty may apply.

What is the tax advantage to a 529 plan? 

Money contributed to a 529 can be invested and grow tax-deferred. This means your money will be able to grow more, as you won’t have to pay tax on your investment gains. 

When money is withdrawn, it’ll be tax-free as long as the funds are used for qualifying expenses. 

If funds are used for another purpose, federal and state income taxes will be owed — and there will usually be a 10% tax penalty, as well. 

Example

Let’s say you open a 529 for your daughter. You and several loved ones regularly contribute money to the account, for total contributions of $10,000. You invest the funds in a broad stock market index fund. 

15 years later, the investments have grown substantially, and the account balance is now $30,000. Your daughter decides to go to college, and you can direct the entire $30,000 balance to be used to pay for her tuition. You won’t owe any tax at all, nor will your daughter. 

On the other hand, if the money is withdrawn to buy a new car, for instance, tax will be owed on the $20,000 investment profit ($30,000 - $10,000 original investment), and an additional 10% penalty will apply. 

Who can open a 529?

There are no income restrictions on a 529, so almost any US adult can open one. 

To open a 529, you must be:

• A US resident

• At least 18 years old

• Have a US mailing address

• Have a social security number or tax ID

Remember, the beneficiary of the account doesn’t need to be 18, but the account opener does. So, you could open a 529 and assign your newborn godchild as the beneficiary, but a 14-year-old cannot open an account for herself. 

Who can contribute to a 529?

Anyone can contribute to a 529 once it’s established. 

A common situation is a parent or guardian will open an account, with a minor assigned as the beneficiary. The parents/guardians can make regular contributions, and grandparents, friends, and other loved ones can also contribute. 

Once money is contributed to a 529, it can’t be withdrawn without the permission of the primary account owner. 

Saving in a 529 vs. improving your own finances 

Contributing to a 529 account on behalf of a child can give them a valuable gift for their future. Particularly if funds are invested wisely, that money can grow over time, and help them substantially with future education costs. 

However, contributing to a 529 should not prevent you from working towards your own financial goals. 

In other words, you should make sure that you’ve paid off all high-interest debt, that your retirement plans are on track, and that you have an emergency fund set aside. 

If you’ve already handled these financial priorities, then contributing to a 529 account on behalf of a loved one is a great idea. 

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