Understanding 529 Savings Plans [2024]

529 savings plans are typically open to residents of any state, while 529 prepaid tuition plans are typically limited to state residents. For states that let nonresidents join their 529 savings plan, keep in mind that states may limit their tax benefits to individuals who join the in-state plan.

Your investment preferences and the college you think the beneficiary might attend will affect your choice. A 529 prepaid tuition plan generally guarantees you a minimum rate of return to ensure that you keep up with college inflation. Essentially, by contributing to such a plan, you lock in tomorrow’s tuition at today’s prices. This can certainly bring you peace of mind. However, if the stock market enjoys an extended period of high returns, you’ll generally still be limited to the return that your plan promises — the entire surplus won’t trickle down to you. Also, to receive the maximum benefits under a prepaid tuition plan, your child must attend a college in that plan. If your child chooses a different school, you may pay a penalty.

By contrast, a 529 savings plan doesn’t guarantee you any minimum rate of return. When you invest your money in a plan’s portfolio (whether it’s an age-based portfolio geared to your child’s age or another portfolio), you take your chances. If your portfolio earns a high rate of return, you’re entitled to all of it. But if it earns little or nothing (or even loses money), you may end up with less than you need to pay for your child’s education.

If you’re a fairly conservative investor and believe that your child will attend a public college in your state, then a prepaid tuition plan may be the appropriate choice (assuming your state offers one). But if you don’t want to restrict your child’s college options or you believe that you can earn a better rate of return than what is promised by a prepaid tuition plan, then a savings plan may be the better option.

There is no beneficiary age limit specified in Section 529, but a few states do impose one. You’ll need to check the requirements of each plan you’re considering. Also, some states may require that the account be open for a specified minimum length of time before funds can be withdrawn. Otherwise, a fee or penalty may be imposed by the state. This is important if you expect to make withdrawals quickly because the beneficiary is close to college age.

Under many 529 plans, you can be both the owner and beneficiary of the account. This can be useful if you are older and plan to attend college or graduate school in the future, or if you are planning for your future children. However, you may lose the estate tax benefits of a 529 plan by naming yourself as the designated beneficiary. And some plans don’t allow the owner and beneficiary to be the same person, so check the terms of the plan you’re considering.

Technically no, because you need a beneficiary’s Social Security number to open an account. But you can go about it in a roundabout way. Because the person you want to name as the beneficiary is not yet born, you’ll need to take two steps. First, you’ll need to open an account and name a beneficiary who is a family member who will be related to your grandchild. Next, when your grandchild is born, you (the account owner) can change the beneficiary to your grandchild.

Check the details of each state’s plan carefully, because some plans impose age restrictions on the beneficiaries (such as being under age 21). That may pose a problem if you plan to name your adult son or daughter as the initial beneficiary. Other plans may require that the funds be spent within a certain time period, such as within 10 years of when the original beneficiary would be expected to enter college.

Yes, with a few limitations. 529 plan applications generally ask for the Social Security number of the account owner and the beneficiary. If you will be the account owner and you don’t have a Social Security number, check with the administrator of the 529 plan before you send any money to see how you’ll be handled. Some 529 plans allow resident aliens to be the account owner, but normally these plans still require a Social Security number.

Another issue can be state residency. Some 529 plans require the account owner to be a resident of their particular state (for a certain time period) before an account can be opened. Alternatively, some plans require that either the owner or the beneficiary be a resident. So if the beneficiary is a resident, you may still be able to open an account even if you’re not a U.S. citizen or resident.

You may expect the beneficiary to attend a foreign college or university. Some foreign colleges and universities are recognized by the U.S. Department of Education as “eligible educational institutions” — a key factor in the income tax treatment of withdrawals from the 529 plan. You should still check the requirements of the 529 plan you are considering to make sure a particular foreign college is an eligible institution.

Yes. You (or anyone else) can open multiple 529 accounts for the same beneficiary, as long as you do so under different 529 plans (savings plan or prepaid tuition plan). For instance, you could open a savings plan account with State A and State B for the same beneficiary, or you could open a savings plan account and a prepaid tuition plan account with State A for the same beneficiary. But you can’t open two separate savings plan accounts in State A with the same plan for the same beneficiary.

Also, keep in mind that if you do open multiple 529 accounts for the same beneficiary, each plan has a limit, and contributions can’t be made after the limit is reached. Some states consider the accounts in other states to determine if the limit has been reached. For these states, the total balance of all plans (in all states) cannot exceed the current year’s maximum contribution amount.

Even if you’ve waited until your child is a sophomore or junior in high school to open an account, this strategy can still make sense because you’ll have at least a few years of potential tax-free growth on your money. But check one issue carefully before you open an account this close to college. Some plans impose a minimum holding period, such as one or two years, before any withdrawals can be made (without penalty). If you’re going to need this money for the first year of college expenses, plans with withdrawal restrictions would not make sense. Check the individual 529 plans for more details.

Essentially nothing. (However, most prepaid tuition plans require that either the owner or the beneficiary be a resident of the state operating the plan, so if you move to another state, you may have to cash in the prepaid tuition plan.) You can leave the account assets in your former state’s savings plan with no penalty. Alternatively, you can roll the assets over from your old state’s plan to a new 529 plan if both plans allow it. Check the details of each plan carefully before you start any transfers.

You can keep the same beneficiary when you do the rollover, but there is a restriction: You can roll the assets over from one 529 plan to another only once every 12 months. If you want to immediately get out of the 529 plan you’re in now and avoid this restriction, you’ll need to change the account beneficiary when you request the transfer.

Some 529 plans also require a minimum time period, such as one year, before withdrawals (including rollovers) can be made from an account for any reason. Again, check both plans to make sure there are no withdrawal limitations.

One advantage of a rollover is that you can reallocate your 529 funds to a different investment portfolio (or portfolios) when you join the new plan. So, you might be able to invest more or less aggressively, depending on your personal situation and market factors.

If you want to contribute to your 529 savings plan and use dollar cost averaging at the same time, you can simply invest a fixed amount in your account at regular intervals (e.g., $200 a month). One way to do this may be to arrange for automatic payroll deductions or bank account debits to be invested in your 529 account. But assuming you have a lump sum of money to invest, is dollar cost averaging better than making a single large contribution? That’s a more difficult question, and the answer depends on your particular circumstances.

According to the experts, the benefit of dollar cost averaging is that it helps you ride out the ups and downs of the market — you buy more shares when the prices are low, and fewer shares when the prices are high. But your decision may be more complicated than it seems. Let’s say you have $100,000 that you’d like to invest in your 529 plan over time using dollar cost averaging. Where will you keep the money in the meantime (e.g., money market fund), and how does your expected return on that investment compare with your expected return in your 529 plan? If you expect to do better with the 529 plan, it might make more sense to invest the lump sum. Remember to compare after-tax return figures, since 529 plan investments accumulate tax free.

Other factors may also enter into this decision. Fees imposed by your 529 plan may decrease as you contribute more money, so investing a lump sum may save you fees over the long run. But a lump-sum contribution may have gift tax consequences that could be avoided by gradually investing the money. Gradual investing might also help you better diversify your 529 plan holdings too. You may want to consult a financial planner or other professional before making this decision.

No. 529 plans do not allow loans against an account’s assets.

No. According to IRS rules, a 529 account cannot be offered as collateral or security to get a loan from either the investment company managing the account or an outside bank or other financial institution.

Ordinarily, yes. In most states, both part-time and full-time students can use 529 funds for qualified college expenses — check with the administrator of your plan. But remember, in all states your child must be enrolled at least half-time to use 529 funds for room and board.

No. The federal definition of “qualified education expenses” that most colleges use doesn’t include general living expenses (e.g., phone charges, transportation, personal expenses). To be covered, expenses must be for something required for enrollment and attendance (e.g., books, a computer), and most living expenses don’t fit into this category. But gray areas exist. For instance, the grocery expenses of students living off-campus may qualify as board charges, so you should address questions like this to your plan administrator or your tax advisor.

If your child receives a college scholarship, you can withdraw — without penalty — funds in your 529 account equal to the amount of the scholarship. In each withdrawal from your 529 plan, you receive some earnings and some of the contributions that were made to the account. Generally, a penalty is imposed on the earnings portion of each withdrawal that you don’t use to pay qualified education expenses. Your child’s scholarship creates an exception — as long as your withdrawals during the year don’t exceed the amount of the scholarship for the year, you will not owe a penalty. But you will owe federal and state income taxes on the earnings portion of each withdrawal.

Withdrawing the funds isn’t your only option. You can leave the funds in the 529 account for your child’s future use (some plans allow 529 funds to be used for graduate school). Or, you can change the beneficiary of the 529 account. If the new beneficiary is a “family member” of the original beneficiary (as defined by Section 529 of the Internal Revenue Code), you won’t owe federal income taxes or a penalty when you make the change.

If your child decides not to go to college, relax — you’ll have several options. First, you can leave the funds in the account. It’s possible that your child will change his or her mind about college at some point in the future. Just keep in mind that prepaid tuition plans generally require that you use the funds within 10 years (savings plans usually allow you to keep the funds in the account indefinitely).

Second, you can change the beneficiary of the 529 account to another family member who will use the funds for college. And finally, you can withdraw the funds and use them for any purpose you choose. The drawback to this option, though, is that you may owe a 10 percent federal penalty tax on the earnings that have accumulated (a state penalty may apply as well). You may also owe federal, and in some cases state, income taxes on the earnings that you withdraw.

Hopefully this won’t happen, but if it does, you have a couple of options. First, you could withdraw the funds from your 529 account and use them for any purpose you choose. Since your child is disabled, you would not owe the 10 percent federal penalty tax that normally applies to nonqualified withdrawals (although you would owe federal, and maybe state, income taxes on the earnings portion of the withdrawal). Or, you could leave the funds in the 529 account and change the designated beneficiary to another qualified family member who will be attending college.

If you withdraw the money that is left over in your 529 account and don’t use it to pay for the beneficiary’s qualified education expenses, you’ll have to pay a federal penalty tax of 10 percent on the earnings portion of the withdrawal (and possibly a state penalty). You may also have to pay federal, and in some cases state, income taxes on the earnings portion of the withdrawal.

However, if you have money left over in your account, withdrawing it and paying a penalty isn’t your only option. All 529 plans allow the account owner to change the beneficiary without penalty (although depending on the plan, there may be a fee for this service). In addition, you may be able to receive a “rollover” distribution from your 529 plan and then contribute these proceeds within 60 days to the same or a different state’s program with a new beneficiary. Keep in mind that in both instances the new beneficiary must be a qualifying family member (as defined by Section 529 of the Internal Revenue Code), or taxes and a penalty will be due.

A delay of 1 or 2 years shouldn’t matter, but if your child postpones college indefinitely, you should read the details of the 529 plan. Look to see if the plan you own (or are considering) has any time limits. Most prepaid tuition plans require that the funds in the plan be paid out within 10 years of the date the beneficiary is scheduled to attend college but savings plans generally have no such requirement, and in most states, money in the account can be left indefinitely.

Direct payment of tuition to an educational institution is not considered a taxable gift. Therefore, you’re able to “give away” more than $18,000 per year for your grandchild’s college education and not worry about gift taxes. The money used to pay the tuition also will not be part of your estate.

With 529 plans, all contributions are considered gifts, so you want to use your federal annual gift tax exclusion. This exclusion lets you give to another person, like your grandchild, up to $18,000 per year without any gift and estate tax consequences. If you contribute more than $18,000 to the same beneficiary during a given year, though, you can avoid gift and estate tax if you elect to treat your contribution (up to $90,000) as if made evenly over a five-year period. However, informational gift tax returns must be filed. In any case, no gift and estate tax must be paid out of pocket until you’ve used up your gift and estate tax applicable exclusion amount.

Section 529 plans offer certain advantages over the direct payment of tuition. First, withdrawals from 529 plans can be used to pay for tuition, fees, books, and even room and board for college and graduate school. The exclusion for direct payment of educational expenses, on the other hand, applies only to tuition. Your grandchild might need significantly more financial assistance.

You should also consider the possibility that you may not live long enough to pay your grandchild’s tuition in the future. In such a case, nothing will be removed from your taxable estate (and the money your grandchild needs for education may not be available). If you contribute money to a 529 plan now, though, your contributions will be considered present interest gifts, and the value of your gifts to the plan will be taken out of your estate. (That is, unless your total gifts in one year are more than $18,000, you elect to treat the gifts as if made over a five-year period, and then you die within the five years. In such a case, the portion of the contribution allocated to the years after your death will be included in your gross estate.)

Very possibly. So far, state laws have largely ignored this issue. But unless future legislation in your state exempts 529 plans from Medicaid rules, you’d be wise to assume that these assets will be subject to the state’s grasp.

To be eligible for Medicaid, most states require that your assets and monthly income fall below certain limits. A state may count the assets and income that are legally available to you for paying bills. You can make assets unavailable by giving them away or by holding them in certain trusts. In some cases, though, such transfers may create a period of ineligibility before you can collect Medicaid.

The potential problem with 529 plans is that your contributions are “revocable.” This means that you can contribute money to your grandchild’s 529 account today, and then take it back (subject to income taxes and a penalty) later. Since it’s possible for you to get your hands on the money, your state Medicaid authorities may consider your 529 gift to be a countable asset when considering your eligibility for Medicaid. That might prevent or delay your eligibility for Medicaid.

In addition, your state has the right to “look back” at your finances 60 months from the date you apply for Medicaid. Contributions you’ve made to your grandchild’s 529 account within this period may delay your eligibility for Medicaid.

You may want to consult a Medicaid planning attorney and keep abreast of changes in your state’s laws with respect to Medicaid and 529 plans.

Generally, yes. You may withdraw funds from your Coverdell ESA and not pay federal income taxes on the withdrawal if you use the funds for qualified education expenses. The rules for Coverdell ESAs consider a rollover contribution to a 529 plan (for the same person who is the beneficiary of the Coverdell ESA) as a qualified education expense. So, the transfer will usually be a nontaxable transfer from the Coverdell ESA to the 529 plan.

There are two ways to explore this rather tricky question. The first way is to examine whether it’s possible to liquidate an UTMA/UGMA account and invest the proceeds in a 529 plan. The second way is to see whether it’s possible to transfer existing UTMA/UGMA assets to a 529 plan.

Before looking at these two questions, it’s helpful to know some basics about UTMA/UGMA (which, by the way, stands for Uniform Transfers (Gifts) to Minors Act) accounts. All gifts to an UTMA/UGMA account are considered irrevocable gifts to the child named as the beneficiary of the account. Once a gift is made, the custodian (usually the parent) can withdraw funds only if the money is used for the child’s benefit. This may include things like private elementary or secondary school, summer camp, a computer, violin lessons, a secondhand car, and so on.

This requirement that the money must be used for the child’s benefit also includes making an investment in a 529 plan, provided the 529 plan is established for the same beneficiary as the custodial account. You can liquidate the investments in the UTMA/UGMA account and invest all of the proceeds in a 529 plan (though you may incur tax liability). The key is that the proceeds must be used for the benefit of the same beneficiary. So, you wouldn’t be able to invest the UTMA/UGMA proceeds in a 529 plan established for a different beneficiary.

The question of keeping your child’s UTMA/UGMA account intact and transferring the assets to a 529 plan is more difficult. Whether this is allowed usually depends on the rules of the 529 plan. In either case — liquidating the UTMA/UGMA account or transferring the assets in the UTMA/UGMA account — there are important things to keep in mind.

First, federal law requires that all contributions to 529 plans be made in cash. Therefore, all assets in an UTMA/UGMA account would first need to be converted to cash if they were not already (e.g., stocks, real estate, certificates of deposit). So, even if the 529 plan accepts the transfer of assets, you will be required to turn those assets into cash. Keep in mind that this may trigger income tax liability.

Second, because the cash will now be held within the UTMA/UGMA account, which, in turn, is in the 529 plan (sort of a cup within a bucket), you are still bound by the rules of UTMA/UGMA accounts. This means that you can’t change the beneficiary of the 529 plan, because gifts to an UTMA/UGMA account are considered irrevocable gifts to the beneficiary. In addition, you must relinquish control of the 529 plan to your child when he or she reaches the age of majority (18 or 21, depending on state law), because this is what happens with an UTMA/UGMA account. And all future contributions you make to the 529 plan will be treated as UTMA/UGMA contributions, meaning that they will be considered irrevocable gifts to the beneficiary. Third, some 529 plans might require that you name the child as the owner (as well as the beneficiary) of the 529 plan after UTMA/UGMA funds are contributed.

Some 529 plans may charge fees, but virtually all college savings options involve fees and expenses of some kind. It’s important to take fees and expenses into account when considering the ways to save for college because they can make a big difference in your total savings over time.

Now would be a good time to review the terms, conditions, and procedures of your 529 plan.

First, you’ll probably have to notify the 529 plan administrator that you need to make a withdrawal for the beneficiary’s college expenses. In most prepaid tuition plans, the payout procedures are standardized. For example, some prepaid tuition plans require that all plan withdrawals must occur within 10 years of the time the beneficiary starts college. Savings plan procedures might differ from plan to plan. Consider the following questions:

• • • What education expenses does the plan consider “qualified”?
    • When must you notify the plan administrator that you wish to withdraw funds from the plan?
    • How do you document that the withdrawal has been used to pay qualified education expenses? How soon must you provide this documentation?
    • Are college expenses paid directly from the plan to the educational institution, or is the beneficiary reimbursed for expenses? How long will reimbursement take?
    • Is a minimum withdrawal amount required, or is there a limit on the number of withdrawals per semester?
    • Does the state’s definition of “eligible educational institution” differ from the federal definition, and does your child’s college satisfy the definition?
    • Does the plan require a minimum level of attendance (e.g., half-time enrollment) for qualified expenses other than room and board?

Second, make sure you understand how a qualified withdrawal from a 529 plan will affect your child’s state income taxes. Some states exempt a plan’s earnings from income tax if used to pay qualified education expenses. Other states tax the earnings. And remember — you’re entitled only to the state tax benefits (if any) offered by the state in which you reside.

Third, explore how a withdrawal from a 529 plan will affect your child’s eligibility for financial aid from the college as well as federal financial aid.

Finally, investigate how to coordinate a 529 plan withdrawal with the American Opportunity credit and Lifetime Learning credit (which you may be able to claim on your federal income tax return) to maximize your income tax benefit. Although you may now claim one of these education credits in the same year you withdraw funds from a 529 plan, your 529 plan withdrawal may not be completely tax free on your federal income tax return that year.