What Is a 529 Savings Plan?

For the 2019 to 2020 school year, the cost of a year of school at a public college for an in-state student, according to U.S. News & World Report, was approximately $10,116, including tuition, fees, and room and board. For out-of-state students, the cost more than doubled to $22,577. A year at a private college averaged even more: $36,801. Therefore, it’s incumbent on families to try to save as much as possible as early as possible to get ahead of rising education costs.

529 savings plans, named after the section of the Internal Revenue Service (IRS) code that establishes the plans, are one of the nation’s most advantageous ways of saving for higher education expenses. These qualified tuition plans allow federal tax-free withdrawal of earnings and possible tax deductions, which can help families afford and pay for the rapidly increasing cost of college. 

A primary benefit of 529 plans is the high contribution limit. Each state operates its own 529 plan and makes its own rules for the plan, so maximum contribution levels vary across states. Typically, 529 limits are high enough that most investors will never have to worry about hitting the ceiling, but those individuals considering attending a private university could find themselves needing to save a significant amount of money to pay college bills.

Key Takeaways

  • A 529 plan allows you to save and grow tax-free money for someone’s education, including your own.
  • Beneficiaries must spend the money on qualified education expenses for the withdrawal to be considered tax free.
  • There are two types of 529 plans: prepaid tuition plans and savings plans.
  • Maximum plan contribution limits vary by state, but such limits generally do not apply across states.

How a 529 Plan Works

A 529 plan allows investors to save and grow money on behalf of a beneficiary, such as a child, grandchild, niece, nephew, or even for themselves. The money grows tax free and can be withdrawn tax free, provided it is used for qualified education expenses, which include tuition; fees; certain electronics, such as a computer; books and other needed classroom equipment; and some room and board costs.

Plan distributions that are used to pay for items that are not qualified educational expenses are taxed and subject to a 10% fee, with exceptions made for circumstances such as death and disability.

There are two main types of 529 plans: prepaid tuition plans, in which the plan holder pays in advance for the beneficiary’s tuition and fees at a specific school, and savings plans, which are tax-advantaged investment vehicles similar to individual retirement accounts (IRAs). 

Plan contribution limits vary from state to state, with Georgia and Mississippi offering the lowest maximum balance, at $235,000, and Pennsylvania, New York, and California the three highest maximum balances, at $511,758, $520,000, and $529,000.

How Are 529 Contribution Limits Determined?

To qualify as a 529 plan under federal rules, plan balances cannot exceed the expected cost of a beneficiary’s qualified education expenses. The generally accepted guideline is that this limit constitutes five years of tuition, room, and board at the most expensive college in the United States.

This guideline makes investment contribution limits quite large, although every state is allowed to individually interpret what five years of qualified education costs means. Therefore, each state has a different contribution limit. Potential contributors should check with the state to determine specific investment maximums.

Although originally structured to fund post-secondary education, 529 plans can now be used to fund private K-12 education, thanks to the passage of the Tax Cuts and Jobs Act.

State-Specific Contribution Limits

Every state’s 529 plan allows for maximum contributions of at least $235,000 per beneficiary. Georgia and Mississippi have the lowest maximum balance limits at $235,000, followed by North Dakota at $269,000.  On the high end, states such as Idaho, Louisiana, Michigan, and Washington, as well as the District of Columbia, have maximum limits of $500,000.     Pennsylvania’s limit is $511,758, South Carolina's and New York’s are both $520,000, and California’s is $529,000.    Once this point is reached, any contributions made to the account are not accepted and will be returned to the investor.

These contribution limits apply to each beneficiary. For example, in Georgia, which has a $235,000 maximum contribution limit, a set of parents contributing $200,000 for a beneficiary and a set of grandparents also contributing $200,000 to the same beneficiary would not be allowed.

Contribution maximums generally do not apply across states. An investor hitting the maximum in one state would likely be eligible to contribute further in another state’s plan. To be safe, individuals should check with plan administrators first to make sure this is allowed.

$371.5 billion

The number of total assets invested in 529 plans as of the end of 2019, according to the latest available information from the College Savings Plan Network. 

Limit for Repaying Student Loans

Under the SECURE Act of 2019, you can also use a 529 plan to pay off up to $10,000 of your existing student loan debt. Note that this $10,000 limit is a cumulative lifetime limit.

Gift Tax Considerations

Outside of a 529 plan, contributions of more than $15,000 per year to any individual would trigger the gift tax. However, there is an exception made for contributions within a 529 plan. A grandparent can, for example, give a $75,000 one-time lump-sum contribution to the plan with the understanding that it would cover five years’ worth of gifts. As long as that person doesn’t contribute again in the next five years, there are no tax consequence.

Your taxable income is not reduced by contributing to a 529 plan. However, more than 30 states give out tax deductions or credits for contributions made to one, according to the informational website Savingforcollege.com.

Who Can Contribute to a 529 Plan?

Anyone can contribute to a 529 plan account and name anyone as a beneficiary. Parents, grandparents, aunts, uncles, stepparents, spouses, and friends are all allowed to contribute on behalf of a beneficiary. While there are no income restrictions for the contributor, the maximum contribution limit applies to the beneficiary, not the individual making the contribution. Balances designated for a specific beneficiary cannot exceed the maximum allowed by the state’s 529 plan.