What Is a 529 Savings Plan?

A 529 savings plan is a tax-advantaged method of saving for future education expenses authorized by Section 529 of the Internal Revenue Code. Legally known as “qualified tuition plans,” 529 savings plans are sponsored by states, state agencies, or educational institutions, and may be used to cover a recipient’s tuition, room, board, books, computers, and other expenses.

Plan holders can use the funds to pay for qualified college expenses, K to 12 tuition expenses, and apprenticeship program expenses. Plan holders can also use the funds to pay for up to $10,000 of student loan debt.

Key Takeaways

  • A 529 savings plan are "qualified tuition plans", a tax-advantaged way to save for education expenses.
  • The two different kinds of 529 plans are prepaid tuition plans and college savings plans.
  • Originally designed to pay for post-secondary education costs, the 529 savings plan was expanded by the Tax Cuts and Jobs Act to cover certain costs associated with K to 12 education.
  • The SECURE Act of 2019 expanded 529 savings plans to cover additional qualified expenses and debts.

Understanding 529 Savings Plans

A 529 savings plan enables an account holder to save money on behalf of a beneficiary. The beneficiary could be a child, grandchild, spouse, or even the account holder. Non-relatives can also establish a 529 savings plan for a designated beneficiary.

The money contributed to a 529 savings account may be invested in equity or fixed-income mutual funds, as well as money market funds, exchange-traded funds (ETFs), and principal-protected bank products. In most cases, the earnings are not subject to federal or state taxes, provided the money is used only for qualified education expenses. The plans are open to both adults and children beneficiaries.

Each U.S. state has its own 529 savings plans, replete with a unique set of features. Individuals living in all states may open a 529 plan, but the plan does not have to be in the account holder's or the designated beneficiary's state of residence. 

Types of 529 Savings Plans

There are two different kinds of 529 plans: prepaid tuition plans and savings plans. All fifty states and the District of Columbia sponsor at least one type of 529 plan.

Prepaid Tuition Plans

Some private universities participate in prepaid tuition plans. With prepaid tuition plans, the account holder buys credits at participating colleges and universities, covering future tuition costs, but locking them in at current prices. Typically offered by in-state, public academic institutions, prepaid tuition plans usually can not be used for future room and board and other ancillary expenses. The federal government does not guarantee prepaid plans. Only certain state governments guarantee the money paid into plans they sponsor, which account holders may lose if the underlying investments experience a drop in value. 

Savings Plans

Savings plans let account holders open an investment account to save for the beneficiary’s future qualified higher education, which includes room and board, as well as the tuition fees. College savings plan accounts generally apply to any university, including non-U.S. institutions of higher learning.

In 2017, the Tax Cuts and Jobs Act (TCJA) expanded the expenses allowed under 529 savings plans. Plan holders can use $10,000 per year tax-free from 529 accounts to pay for K to 12 education tuition and other qualified expenses. The SECURE Act of 2019 expanded 529 plans even further, allowing participants to use the funds to pay for certain expenses associated with registered apprenticeship programs. Additionally, the SECURE Act allows plan holders to use up to $10,000 to pay the principal and/or interest on the beneficiary's qualified student loan debt.

Special Considerations

It’s important to recognize that fees associated with 529 plans may lower returns and that fees may vary depending on whether the type of 529 plan in question is a savings plan or prepaid tuition plan. Therefore, it is incumbent on account holders to investigate the fee structure before setting up either plan, in order to fully understand the terms of each investment option. Both plans may charge application fees and ongoing administrative fees.