First things first

What is a 529 Plan?

You’ve probably heard of a 401K plan, it’s an account that’s meant to help people save for retirement. When used correctly, it can come with great tax benefits - the timing of those benefits can vary based on whether its a traditional or Roth account.

Well, a 529 plan is an account that means to help people pay for college (or other educational expenses). When used correctly, it can also come with amazing tax benefits - along with other perks, all of which we will dive into today!

Generally, an adult sets up the plan and then designates a beneficiary. Usually, anyone can set one up and name anyone as the beneficiary. The beneficiary is the student, or future student, for whom you intend to use the account benefits. For example, I opened a 529 plan last month for Baby G. It is my account, I am the custodian, I own it the account until the funds are spent. But, I’ve designated Baby G as the beneficiary because I plan to use it to pay for his college expenses. Often, this beneficiary may be updated tax and penalty free provided the new designated beneficiary is another member of the family (make sure to check your state plan to see if this applies to you).

Here’s how it works! You put money into the account, that money gets invested, the money can grow tax-free, and it can be used to pay for qualified educational expenses TAX-FREE - even the growth.

When you make contributions to a 529 plan, your state may offer a tax deduction for those contributions- or at least some of them, but I can’t stress this enough, this varies by state!

Now, while you don’t get a tax deduction on contributions on federal taxes, the growth is not subject to federal, or state, taxes provided the distribution is used to pay for qualified educational expenses.

So what can you spend that money on tax-free? These expenses will vary for everyone, but in general includes tuition for college, higher education, or K-12. You may also use those funds to pay for other educational related expenses such as computer technology, equipment, or even internet access as long as they are being used by the beneficiary of the plan while they are enrolled at an eligible educational institution.

Qualified educational expenses can also include cost included from other fees, books, and supplies.

There’s even an option to spend some of the funds on student loans!

What if my kid doesn’t go to a traditional college?

The 529 plan is a lot more flexible than people think! These funds can be used to pay for non-traditional education- like trade school!

What if there’s funds leftover in the account, what happens to that money?

That’s a valid question! Maybe the beneficiary got a scholarship, didn’t use all the funds, or maybe they decided they didn’t want to do any sort of school. In that case you have options!

Like I mentioned above, you may be able to update and designate a new beneficiary, that’s one option. This keeps all the same benefits and passes them on to someone else who could use them.

Option two, you can take the money out. The contributions are, generally, not taxed federally as they were made with after tax dollars, but the earnings will be taxed as ordinary income and subject to a 10% penalty. If your state offered a state tax deduction or tax credit on contributions, the state may claw back those benefits. You may also be looking at state tax if applicable and/or penalties on earnings.

Option 3, you can put that money into the beneficiaries Roth IRA! There is a lifetime limit of $35,000 per beneficiary and is subject to the annual rollover limit capped by the beneficiaries Roth IRA contribution limit ($7,000 for 2025). Also, the 529 plan must have been open for the same beneficiary for at least 15 years before any rollover, and only contributions and earnings older than five years would be eligible for the rollover. There are a lot of rules and guidelines for this option, so make sure you do your due diligence if this is something you’d like to do. You can find more info from the IRS here.

What if I don’t have a lot to start with?

That’s ok! I want to emphasize that you do not need a lot of money to start with! Some people start with $25 a month and add in birthday money or gifts for other special occasions. We aren’t talking about thousands of dollars! A little can go a long way, especially when you are starting the account for a beneficiary that is very young. That’s things to something called compounding interest, which is your money making money – then the money that your money made making more! The more time that you allow for the money to grow, the quicker it can grow.

Some people are able to contribute a large chunk when their child is young, and never worry about it again. You do what you can and what works for you!

Want to learn more about investing and how to get compounding interest?

I have a free class coming up with licensed financial advisor Jose Hernandez. We will be covering how to get started investing in plain English! The class is on 12/29 @ 7pm ET, you can sign up below.

Capacity is limited, so make sure you reserve your spot!