529 Plan Guide: How to Save for Education Tax-Free

A 529 plan is a tax-advantaged investment account specifically designed to help families save for education expenses. Named after Section 529 of the Internal Revenue Code, these accounts offer federal tax-free growth and tax-free withdrawals when funds are used for qualified education expenses—from college tuition to K-12 schooling to apprenticeship programs. With over 30 states offering additional tax deductions or credits for contributions, and recent legislation adding a game-changing Roth IRA rollover option, 529 plans have become one of the most powerful tools for building an education fund. Whether you're a new parent planning ahead or a grandparent looking to help with college costs, understanding how 529 plans work can save your family thousands in taxes.

What Is a 529 Plan and How Does It Work?

A 529 plan functions similarly to a Roth IRA—you contribute after-tax dollars, your money grows tax-free, and qualified withdrawals are completely tax-free. The key difference is that 529 plans are specifically designed for education expenses rather than retirement.

Here's how the basic structure works:

• Account owner (typically a parent or grandparent) opens and controls the account
• Beneficiary (usually a child) is the person whose education expenses the funds will cover
• Contributions go into investment options that grow over time through compound interest
• Withdrawals are tax-free when used for qualified education expenses

According to the IRS, anyone can open a 529 plan regardless of income level—there are no income restrictions like there are with Roth IRAs. You can also use funds at over 6,000 U.S. colleges and universities, plus more than 400 international schools.

Two Types of 529 Plans

529 College Savings Plans

The most common type, college savings plans work like investment accounts. Your money goes into a portfolio of mutual funds or ETFs, and the account value fluctuates based on market performance.

Key features include:

• Age-based portfolios that automatically shift from aggressive to conservative investments as your child approaches college
• Static portfolios where you choose a fixed allocation based on your risk tolerance
• Flexibility to use funds at any eligible institution nationwide
• Broader expense coverage including tuition, room and board, books, and computers

Prepaid Tuition Plans

Prepaid plans let you lock in today's tuition rates at participating in-state public colleges. You're essentially prepaying for future education at current prices.

However, prepaid plans have significant limitations:

• Only available in a handful of states (Florida, Massachusetts, Michigan, Mississippi, Nevada, Texas, Washington)
• Typically limited to tuition and mandatory fees only
• Usually restricted to in-state public institutions
• Less flexible if your child chooses a different school

For most families, a 529 college savings plan offers more flexibility and broader benefits.

529 Plan Tax Benefits Explained

Federal Tax Advantages

The federal tax benefits of 529 plans are substantial:

1. Tax-deferred growth: Your investments grow without annual capital gains taxes eating into returns
2. Tax-free withdrawals: When used for qualified expenses, you pay zero federal tax on earnings
3. No contribution deduction: Unlike traditional retirement accounts, contributions aren't federally tax-deductible

State Tax Benefits

This is where 529 plans can really shine. According to SavingForCollege.com, over 30 states offer income tax deductions or credits for 529 contributions. Some states limit the benefit to their own plans, while others offer "tax parity"—allowing deductions for any state's plan.

Gift Tax Treatment and Superfunding

529 contributions qualify for the annual gift tax exclusion—currently $19,000 per donor per beneficiary in 2025-2026. But there's a unique superfunding option that lets you contribute up to five years' worth at once:

Superfunding is particularly powerful because it gets money working through compound growth immediately. A grandparent contributing $95,000 when a child is born could see that grow to $250,000+ by college age, all tax-free.

What Are Qualified Education Expenses?

Understanding exactly what you can pay for with 529 funds is crucial. Using funds for non-qualified expenses triggers a 10% penalty plus income taxes on the earnings portion.

Higher Education (College/Graduate School)

For post-secondary education, qualified expenses include:

• Tuition and mandatory fees at eligible institutions
• Room and board for students enrolled at least half-time (including off-campus housing up to the school's cost of attendance allowance)
• Books, supplies, and required equipment
• Computers, internet, and software for educational use
• Special needs services and equipment

K-12 Education

Since 2018, 529 plans can also cover K-12 tuition at public, private, or religious schools—but with an important limitation: the withdrawal cap is $10,000 per year per beneficiary (increasing to $20,000 in 2026). This covers tuition only, not supplies or other expenses.

Expanded Uses from Recent Legislation

The SECURE Act and subsequent legislation expanded 529 qualified expenses to include:

• Registered apprenticeship programs (since 2019)
• Student loan repayment: Up to $10,000 lifetime per beneficiary (SECURE Act 2019)
• Credentialing programs (OBBBA 2025)

The SECURE 2.0 Roth IRA Rollover Option

One of the most exciting developments for 529 plans came from SECURE 2.0: the ability to roll unused 529 funds into a Roth IRA for the beneficiary. This addresses the longstanding concern of "what if my child doesn't need all the money?"

Requirements for 529 to Roth Rollover

According to Investopedia, you must meet these criteria:

• $35,000 lifetime limit per beneficiary
• 529 account must be open for at least 15 years
• Rollovers are subject to annual Roth IRA contribution limits
• Beneficiary must have earned income to receive the rollover
• Contributions made in the last 5 years (and their earnings) cannot be rolled over

This provision creates a safety net for 529 savers. Even if your child earns scholarships, attends a less expensive school, or chooses a different path, those funds can jump-start their retirement savings through a Roth IRA.

Investment Options and Strategies

Age-Based Portfolios

Most families choose age-based portfolios, which work similarly to target-date retirement funds. When your child is young, the portfolio holds more stocks for growth potential. As college approaches, it automatically shifts toward bonds and stable value funds to protect against market downturns right when you need the money.

This hands-off approach works well for most families who want to set it and forget it.

Static Portfolios

If you prefer more control, static portfolios maintain a fixed allocation you choose:

• Aggressive growth: Higher stock allocation for younger beneficiaries
• Moderate: Balanced mix of stocks and bonds
• Conservative: More bonds and stable value for near-term needs
• Index funds: Low-cost index fund options in many plans

Important Investment Restrictions

The IRS limits how often you can change your 529 investments—only twice per calendar year for the same beneficiary. This prevents frequent trading but means you should choose your strategy carefully upfront.

How 529 Plans Affect Financial Aid

Understanding the financial aid implications helps you structure your 529 savings optimally.

Parent-Owned 529 Plans

When parents own the 529 account:

• The account is reported as a parent asset on the FAFSA
• Only 5.64% of the value is counted toward your Expected Family Contribution (EFC)
• Distributions are not counted as student income

This is favorable compared to student-owned assets, which are assessed at 20%.

Grandparent-Owned 529 Plans

Good news for grandparents: As of the FAFSA Simplification Act changes, grandparent-owned 529 accounts are no longer reported on the FAFSA. Previously, distributions from grandparent 529s counted as student income and could significantly reduce aid eligibility. This change makes grandparent 529s an even more attractive option.

How to Choose the Best 529 Plan

You're not limited to your own state's plan—you can open a 529 in any state. Here's how to evaluate your options:

Step 1: Check Your State's Tax Benefits

If your state offers a tax deduction or credit for contributions, calculate its value. A 5% state tax deduction on $10,000 in contributions saves $500 annually—that can add up significantly over time.

Step 2: Compare Fees

Morningstar rates 529 plans and notes that expense ratios range from 0.01% to over 0.80%. Lower fees mean more money stays invested and growing.

Step 3: Evaluate Investment Options

Look for plans with:

• Quality underlying funds (index funds, low-cost options)
• Age-based portfolios that match your preferences
• Sufficient diversification options

Step 4: Consider Plan Ratings

Morningstar's top-rated 529 plans (Gold rating) include:

• Utah my529
• Alaska T. Rowe Price College Savings Plan
• Pennsylvania 529 Investment Plan
• Massachusetts U.Fund College Investing Plan
• Illinois Bright Start Direct-Sold College Savings

Direct-Sold vs. Advisor-Sold Plans

Direct-sold plans have lower fees and you manage investments yourself. Advisor-sold plans include professional guidance but charge higher fees. For most investors comfortable with basic decisions, direct-sold plans offer better value.

What Happens to Unused 529 Funds?

One common concern about 529 plans is flexibility—what if your child doesn't use all the money? You have several options:

Change the Beneficiary

You can transfer the account to another "member of family" tax-free. This includes:

• Other children, grandchildren, or stepchildren
• Siblings and step-siblings
• Parents, grandparents, nieces, nephews, cousins
• In-laws and spouses

Roll Over to a Roth IRA

As discussed above, SECURE 2.0 allows up to $35,000 lifetime to be rolled into the beneficiary's Roth IRA (subject to requirements).

Use for Your Own Education

The account owner can change the beneficiary to themselves and use funds for their own qualifying education—perhaps graduate school or professional development courses.

Take a Non-Qualified Withdrawal

As a last resort, you can withdraw funds for any purpose. You'll pay income tax plus a 10% penalty on the earnings portion only—your original contributions come out tax-free.

The penalty is waived if the beneficiary:

• Receives a scholarship (can withdraw up to the scholarship amount)
• Dies or becomes disabled
• Attends a U.S. military academy

529 Plan vs. Other Education Savings Options

For dedicated education savings with the highest contribution limits and favorable financial aid treatment, 529 plans generally win.

Getting Started with a 529 Plan

Ready to open a 529? Here's your action plan:

1. Research your state's plan and any tax benefits for in-state contributions
2. Compare top-rated plans using Morningstar ratings and fee comparisons at SavingForCollege.com
3. Open an account online (most plans have $0-$100 minimums)
4. Set up automatic contributions to build the habit—even small amounts add up through compound growth
5. Choose age-based portfolios unless you have specific investment preferences

If you haven't already, consider creating a budget that includes regular 529 contributions alongside your other investing goals.

Conclusion

529 plans offer a rare triple tax advantage: tax-free growth, tax-free withdrawals for education, and potential state tax deductions. With the addition of the Roth IRA rollover option, they've become more flexible than ever—your education savings no longer have to be "use it or lose it."

The best time to start a 529 is when your child is young, giving compound growth maximum time to work. But even starting later provides valuable tax benefits. Whether you're saving for a newborn's future college tuition or helping a teenager build their education fund, a 529 plan deserves serious consideration as part of your family's financial strategy.