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Using 529 Plans to Save for College

A 529 plan is an education savings plan operated by a state or educational institution designed to help families set aside funds for future college costs. Like other financial accounts with numbers in the title, 529 plans get their name from Section 529 of the Internal Revenue Code, which lays out the plans' governing rules. (For more, see: 529 Plans: Type of Plans.)

Benefits of a 529

529 plans have four primary benefits:

  • All 529 plans allow earnings to grow and be used tax-free as long as the money is taken out to pay for college. 
  • Many states currently offer residents a full or partial state income tax deduction or credit for 529 plan contributions.
  • With few exceptions, the named beneficiary has no legal rights to the money inside the 529 so the account owner can be confident the money is not misappropriated.
  • 529 plans have no income restrictions, age thresholds or annual contribution limits so anyone can set one up. Additionally, high net-worth savers looking to reduce estate taxes can elect to “superfund” a 529 and treat a plan contribution of up to $70,000 per person as if it were made over a five-calendar-year period. This allows the contribution to qualify for the $14,000 annual gift tax exclusion. Using this approach, a husband and wife could fund a 529 with a single contribution of $140,000.  

Using a numerical example, if a saver contributed $250 per month to a 529 plan for 18 years and earned annualized returns of 6.5%, the account would be worth approximately $102,000 by the time the student was college age. In this illustration, the saver contributed $54,000 and had $48,000 of capital gains. This entire amount could be used tax-free to pay for the cost of the beneficiary’s college expenses. (For related reading, see: The Advantages of Automating Your Financial Life.)

529 Savings Plans

If you know you want to save for college, and you are comfortable investing in stocks and bonds, a 529 savings plan will allow you to invest in mutual funds or fixed income investments that are tied to the broader market. Every state has different investment options, so do your research and find the plan best suited for your goals. Importantly, if you live in a state without an income tax, you will receive no added tax benefits to contributing to your own state’s 529 plan. 

You should compare all of your options (in-state and out-of-state) and contribute to the plan with the investment options that align with your objectives.  There are no requirements that you live in, or the beneficiary attend school in, the same state as the 529. For example, a Texas resident that contributes to a Nevada 529 plan will not be penalized if his children elect to go to school in Florida.    

529 Prepaid Plans

Prepaid plans aren’t available in every state or for every school, but they can be ideal for savers that want to avoid market volatility. Like the name implies, prepaid plans allow savers to prepay tuition and mitigate the risk of rising tuition costs without investing directly in the financial markets. (For more reading about investing in the financial markets, see: The Hidden Cost of Hedge Funds.)  

Paying for Public School

If you are set on having your child or grandchild go to state school, look into whether your state has a prepaid tuition program. For example, Texas has the Texas Tuition Promise Fund. It is a 529 that allows you to buy tuition credits today for use at any state school down the road. If the beneficiary chooses to go elsewhere, the account value will be the lesser of the prevailing Texas state school tuition or the returns of the underlying portfolio.  Twenty-one states currently have similar plans, but only fifteen are currently accepting new applicants.

Paying for Private School

If you have your heart set on sending your loved ones to private school, the Private College 529 plan may be the best thing available. It allows you to pay your tuition at today’s prices and not worry about market fluctuations or timing. If the beneficiary chooses not to go to one of the participating private schools, you can roll the money into a traditional investment-based 529 savings plan and be credited with annualized returns between -2%–2% based on the performance of the trust. All of the other 529 rules apply.  

A Non-529 Solution

With all 529s there is a chance that the child or grandchild won’t use the money for education. In this case, a 529 account holder could be forced to withdraw the funds for non-education purposes. This would lead to income tax and a 10% penalty on the growth. Additionally, when investing in stock or bond funds, there is always the chance that the market will be down when you absolutely need to withdraw the money.

For investors that want to mitigate the above risks, one solution is to buy tax-free, high-credit quality, zero coupon municipal bonds that mature when the money will be needed. For example, if the child will start school in 2020, the investor would buy a bond ladder maturing between 2020 and 2024.  For many investors living in states that don’t provide income tax deductions or credits for 529 plan contributions, tax-free municipal bonds have similar effective tax consequences as 529 plans without many of the restrictions. (For more reading about savings plans, see: Using Health Savings Accounts for Retirement.)


Talking about a broad topic like 529s and tax-free bonds cannot be complete in the space of a few paragraphs. So keep in mind that the information contained herein (1) is intended solely for informational purposes; (2) is not warranted to be complete, or timely; and (3) does not constitute investment advice of any kind. Tri-Star Advisors is not responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. Consult an investment advisor to discuss your personal situation.