The Complete Guide to 529 Plans: How to Save for College Tax-Free

Table of Contents Navigation

• Key Takeaways

• What is a 529 College Savings Plan?

• How 529 Plans Work

• Key Benefits of 529 Plans

• Qualified vs. Non-Qualified Expenses

• Impact on Financial Aid

• How to Choose the Best 529 Plan

• Recent Changes and Updates

• Conclusion

As a parent, you dream of giving your child every opportunity. That often starts with education. But with the cost of college skyrocketing over the years, it is easy to feel overwhelmed. According to the College Board, the average annual tuition is:

• Public four-year in-state university: $11,610

• Out-of-state public four-year universities: $30,780

• Four-year private colleges: $43,3500 per year.

For families seeking to alleviate the financial burden of higher education, 529 education savings plans are among the most effective tools available to them. These tax-advantaged accounts allow your education savings to grow tax-deferred, potentially saving thousands of dollars in the long run.

What is a 529 College Savings Plan?

A 529 plan is a state-sponsored education savings account that offers tax-deferred growth and tax-free withdrawals when funds are used for qualified education expenses. Named after Section 529 of the Internal Revenue Code, these plans combine the growth potential of investment accounts with significant tax benefits, making them an essential component of any comprehensive education funding strategy. Think of it as a Roth IRA for education – you contribute after-tax dollars, but all future growth and withdrawals for educational purposes are tax-free.

The concept is straightforward: you open an account, choose from various investment options, make regular or periodic contributions, and watch the money grow tax-deferred over time. When your child is ready for college (or you have other qualified education expenses before then), you can withdraw the funds without paying taxes on the earnings, provided the money is used for qualified education expenses. Qualified education expenses generally include: tuition and fees, books, supplies, and equipment.

How 529 Plans Work

The mechanics of a 529 plan are designed for simplicity and long-term growth. Here's how the process typically works:

• Contributions: While there are no annual limits at the federal level that you can contribute to a 529 plan, the actual state-sponsored plans themselves have varying total account maximums based on the most expensive university in a state, allowing contribution limits of $250,000 - $500,000 in most state plans. In 2025, an individual can gift up to $19,000 ($38,000 for couples) in a single 529 plan without incurring gift tax. This amount aligns with the IRS annual gift tax exclusion, which allows you to gift up to $19,000 per person ($38,000 per couple) per year without filing a gift tax return. Additionally, while there is no federal income tax deduction for contributions, states that have a state income tax may offer a state income tax deduction for those residents who contribute to their state's College Savings Plan. These contributions are then invested in your chosen investment options, which usually include age-based portfolios that automatically adjust risk levels as your child approaches college age.

• Growth: Your investments grow tax-deferred over time. Similar to a retirement account, you won't pay annual taxes on dividends, interest, or capital gains within the account. Investment options for Savings Plans typically include mutual funds and annuities, and most Savings Plans offer age-based investments that become more cautious as the beneficiary gets closer to age 18. The account owner is permitted to change the investment selection up to twice per year.

• Withdrawals: Distributions for qualified education expenses are tax-free and penalty-free. Accumulated earnings withdrawn for purposes other than qualified education expenses are taxable and carry a 10% penalty tax. For non-qualified expenses, the earnings portion of the distribution will always be subject to income tax; however, there are some exceptions where the 10% penalty would be waived, which include:

  • A beneficiary dies or becomes disabled.

  • A beneficiary receives a tax-free scholarship.

  • A beneficiary receives educational assistance through a qualifying employer program.

  • A beneficiary attends a U.S. Military Academy.

  • The taxpayer used qualified education expenses to generate the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Tax Credit (LLTC).

Key Benefits of 529 Plans

The tax advantages of 529 plans are what make them particularly compelling savings vehicles. At the federal level, all growth and qualified withdrawals are tax-free, resulting in significant savings over time. Most states with income taxes also offer additional benefits, such as state income tax deductions or state tax credits for contributions. To see if your state offers tax incentives for 529 contributions, check out this article.

529 plans feature high contribution limits, with most states allowing total contributions of hundreds of thousands of dollars per beneficiary. Unlike certain investment accounts, like Roth IRAs, there are no income restrictions for 529 plan contributions, making them accessible to families at all income levels.

The investment options in modern 529 plans are sophisticated and diverse. Most plans offer age-based portfolios that automatically adjust from aggressive growth investments when children are young to more conservative options as college approaches. You can also select static portfolios tailored to your risk tolerance and investment preferences.

529 plans do not have age restrictions or required distribution dates, unlike other tax-advantaged accounts. This flexibility allows unused funds to remain in the account indefinitely or be transferred to other eligible family members.

529 plans also allow for accelerated gifting, where you can contribute up to five years' worth of annual gift tax exclusions at once. Therefore, for individuals who would like to gift up to five years' worth of contributions to a 529, they can do so in the amount of $95,000 per giftor or $190,000 for a couple in 2025. This is sometimes referred to as 'superfunding' a 529.

The power of compound growth makes starting early essential for 529 plan success. Even modest contributions can grow significantly over 18 years. For example, contributing $200 per month starting when a child is born could result in over $74,000 by age 18, assuming a 6% annual return. Consider setting up automatic contributions to ensure consistent savings. Many families find success by increasing contributions annually or using windfalls like tax refunds or bonuses to boost their 529 accounts.

Qualified vs. Non-Qualified Expenses

Understanding what constitutes qualified education expenses is crucial for maximizing the benefits of your 529 plan. Here is a list of qualified education expenses, along with some other common expenses that are not qualified:

• Tuition and fees: Qualified up to the full amount of college or vocational school tuition and required fees.

• Books and supplies: Qualified for college expenses only.

• Computers, software, and internet access: Qualified for college expenses only.

• Room and board: Qualified for college expenses only if the student is enrolled at least half-time.

• Special needs equipment: Qualified for college expenses only.

• Transportation and travel costs to and from campus (e.g., airfare, gas, etc.): Not qualified.

• Health insurance: Not qualified, including policies offered by the school.

• College application and testing fees: Not qualified.

• Extracurricular activity fees: Not qualified.

• Student Loans: Qualified up to a lifetime limit of $10,000.

In 2018, federal tax law changes expanded the definition of qualified expenses to include up to $10,000 per year for K-12 tuition expenses. However, keep in mind that, despite being qualified at the federal level, your state may still deem them non-qualified.

• Qualified expenses for enrollment or attendance at an elementary or secondary school include tuition, fees, academic tutoring, books, supplies, equipment, and special needs services for beneficiaries with disabilities.

• For homeschool settings, qualified expenses cover curriculum and instructional materials, books, online learning resources, tutoring and classes taken outside the home, dual enrollment in college or university courses, and educational therapy for students with disabilities. Keep in mind that tutors or instructors cannot be related to the student.

Impact on Financial Aid

A common concern for families using 529 plans is how they impact financial aid eligibility. The key factor is who owns the account. If a parent or dependent student owns a 529 plan, it is reported as a parent asset on the Free Application for Federal Student Aid (FAFSA). Any parental assets, such as brokerage accounts, savings accounts, and other assets, will reduce the student's aid package by a maximum of 5.64% of the asset's value. Therefore, if a parent-owned 529 account is valued at $10,000, their child's financial aid award could be reduced by as much as $564.

Lastly, 529 plans owned by a grandparent or other relative are not included on the FAFSA.

In contrast, student-owned assets like UTMA/UGMA accounts are assessed at 20%, making 529s a more aid-friendly option. Therefore, if the student had a UTMA valued at $10,000, they would receive up to $2,000 less in financial aid.

Earnings within 529 plans are not reported as income on the FAFSA, and qualified withdrawals are not treated as income either, regardless of who owns the plan.

How to Choose the Best 529 Plan

Selecting the right 529 plan requires evaluating several key factors. Start by examining your home state's plan, as many states offer tax deductions or credits for residents who contribute to their state's 529 plan. However, don't let state benefits be your only consideration – a plan with high fees or poor investment options may not be worth a small tax deduction.

Investment performance and fees are critical factors in long-term returns. Look for plans with low expense ratios and strong historical performance.

Here are some questions to ask yourself as you try to find the best 529 plan for your circumstances:

• Do you live in a state with no income tax? If so, you are better off finding the best plan you can – one with the best investment options and lowest fees.

• Do you live in a state with income taxes, but no tax break for contributions to a 529 plan? Again, since there is no tax benefit, you are better off finding the plan with the best investment options and lowest fees.

• Do you live in a state that offers a state tax benefit for a contribution made to any state's 529 plan (e.g., you live in New York but can get a state tax benefit for a Missouri Plan)? This still does not matter which plan you choose, go with the best one.

• Do you live in a state that offers a state tax benefit only for contributions made to a 529 plan in the state in which you live? You'll typically stick with that state's plan.

Choosing the Best 529 Plan for You Workflow

Consider the plan's investment options and whether they align with your risk tolerance and time horizon. Generally, it's a good idea to opt for age-based portfolios due to their automatic rebalancing and appropriate risk adjustment over time.

Recent Changes and Updates

Starting in 2025, the One Big Beautiful Bill (OBBBA) expands how you can use your 529 plan, making it even more flexible for families. In addition to covering up to $10,000 per year in K-12 tuition, the new law expands the list of other K-12 education expenses that qualify for tax-free 529 withdrawals. These include things such as textbooks, online learning materials, tutoring (from a qualified, unrelated tutor), standardized test fees (like the SAT or AP exams), dual enrollment fees for college classes taken in high school, and even educational therapies for students with disabilities. Beginning in 2026, the annual limit for these K-12-related expenses will also double, from $10,000 to $20,000 per year.

These new rules apply to any 529 distribution taken after July 4, 2025, even if the qualifying expense was paid earlier in the same year. As long as the distribution occurs after the law takes effect, it can still be used to reimburse eligible costs incurred earlier in the year.

The law also broadens the definition of qualified expenses to include postsecondary credentialing programs. 529 funds can now be used for tuition, fees, and books related to programs that lead to a professional license, trade certification, or apprenticeship. This includes the cost of required exams and continuing education to maintain a credential's current status. To qualify, the program must be accredited, industry-recognized, registered with the U.S. Department of Labor, or fall under definitions in the Workforce Innovation and Opportunity Act.

Conclusion

529 college savings plans are one of the most powerful tools available for education funding. Their combination of tax-deferred growth, flexible investment options, and high contribution limits makes them essential for families serious about education planning.

The key to 529 plan success is starting early, contributing consistently, and choosing a plan with reasonable fees and appropriate investment options. While the landscape of education funding continues to evolve, 529 plans remain a cornerstone of smart financial planning for families with educational goals.

Whether you are a new parent just starting to think about college costs or someone looking to optimize your existing education savings strategy, 529 plans offer a proven path to building tax-free wealth for education expenses. The earlier you start, the more time compound growth has to work in your favor, potentially saving thousands of dollars in taxes and ensuring your children have the educational opportunities they deserve.

Consider consulting with a financial advisor to determine the best 529 plan strategy for your specific situation and to ensure your education savings plan aligns with your overall financial goals.

Need help figuring out if a 529 fits into your financial plan? Reach out, we're here to help you make the most of your retirement and charitable giving needs. You can schedule a complimentary, no-obligation call with us here.

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About the Author

Holzberg Wealth Management is a family-owned and operated financial planning and investment management firm based in Marin County, CA. As your financial advisors, we serve you as a fiduciary and are fee-only, so we never receive commissions of any kind. We help individuals and families like you in the greater San Francisco Bay Area and nationwide with the financial decision-making process to organize, grow, and protect your assets.

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