Highlights
- While contributions to 529 plans are not federally tax-deductible some federal tax benefits exist.
- States offer tax deductions or credits for contributions.
- Contributions grow tax-free and can be withdrawn tax-free if used for qualified education expenses.
- Taxes and penalties may apply if 529 funds are used for non-qualified expenses
- Unused 529 funds can remain in the account for future educational use, pay off student loans, be transferred to a Roth IRA, or rolled over to another family member’s 529 or ABLE account.
What A 529 Plan Is
Americans use 529 plans to save for education expenses including college and trade schools for children or other designated beneficiaries. But you can open a 529 plan account for anyone – even yourself.
There are two types of 529 plans: Education Savings plans and Prepaid Tuition plans. An Education Savings Plan (ES) saves for the beneficiary’s future education expenses. A Prepaid Tuition Plan (PT) pays for future college expenses (often at a specific institution) at current prices, even if the beneficiary won’t attend college until many years later.
The education savings are most popular 529 plans, so they are the main focus of this discussion.
Most 529 plans are set up and managed by states, although educational institutions can also sponsor prepaid 529 plans. You don’t necessarily have to do it with your state’s 529 plan. You’re free to shop around.
529 plans are popular because,
- It’s generally easy to open and manage an account.
- Funds can be used to pay for a variety of educational expenses.
- There are no income restrictions for contributing to a 529 plan.
- Tax advantages that 529 plans offer are also a big draw.
While there are no contribution limits for 529 plans under federal law, taxes and penalties may be due if total contributions exceed the beneficiary’s expected qualified education expenses. State sponsored 529 plans set a maximum balance per beneficiary (typically between $500,000 and $600,000).
529 Plan Contribution Tax Benefits
One might assume that contributions to 529 plans are tax deductible. But there is no federal tax deduction for contributions to a 529 plan, but other federal benefits available.
However, most states offer either a tax deduction or credit for contributions to 529 plans (except states without an income tax). How much of a tax break varies by state and can range from a few hundred dollars to several thousand dollars.
Often limitations and restrictions on state tax breaks exist, examples include:
- You might have to contribute to the plan sponsored by your state to qualify for a deduction or credit.
- You might not be able to deduct or claim a credit for each year’s contributions.
- State tax breaks tend to be capped.
- Check your state tax agency to determine what tax breaks are available when you invest in a 529 account.
There are federal tax breaks available for 529 plans, such as:
- Money in a 529 account grows tax-free, so there are no income taxes to pay on earnings each year.
- Funds for qualified education expenses can be withdrawn without having to pay capital gains taxes.
Qualified vs. Non-qualified 529 Plan Expenses
Generally, there’s no federal income tax on money taken out of a 529 plan if it’s used to cover the beneficiary’s qualified education expenses.
Qualified education expenses include any costs required for the enrollment or attendance at a college, university, vocational school, or other postsecondary educational institution eligible to participate in a federal student aid program administered by the U.S. Department of Education. This includes public or private colleges, community colleges, graduate schools, trade schools, and more.
Qualified expenses that 529 funds can be used to pay for are:
- Tuition, fees, books, supplies, and equipment required for enrollment or attendance,
- Room and board for a student enrolled on at least a half-time basis,
- Special needs services, such as tutoring, counseling, service animals, and the like,
- Computers and peripheral equipment, software, and internet access
Other Qualified education expenses include tax free withdrawals for:
- Tuition at an elementary, middle, or high school (up to $10,000 per year)
- Student loan payments (up to $10,000 per beneficiary)
- Apprenticeship program fees, books, supplies, and equipment
Non-qualified expenses for which 529 funds cannot be used include:
- Transportation to and from school
- Extracurricular activities
- Health insurance for students
- College application fees
- SAT or ACT preparation courses
- Software designed for sports, games, or hobbies (unless it’s predominantly educational in nature)
- Personal expenses such as clothes, phones, entertainment, and the like also do not qualify.
Taxes and Penalties If 529 Funds are Used For Non-qualified Expenses
If you use 529 funds for other purposes, some tax breaks go away and you might also have to pay an additional penalty. Common examples are:
- The amount withdrawn from a 529 plan during the year is greater than the beneficiary's qualified education expenses for that year. That excess portion of withdrawn earnings may be subject to federal income tax. However, there’s no tax on any contributions withdrawn from the account.
- You might owe a 10% penalty on the taxable amount (i.e., the amount above qualified education expenses for that year).
- Whoever receives 529 funds not used for qualified education expenses is responsible for any tax on earnings, whether the person who opened the account or the beneficiary. If a plan withdrawal is sent directly to the beneficiary’s school, it is treated (for income tax purposes) as if the beneficiary received the funds.
But there are some situationswhere theIRS will generally waive the penalty:
1. The penalty generally won’t be applied if the beneficiary dies or becomes disabled.
2. The beneficiary attends a U.S. military academy (such as West Point or the Naval Academy).
3. The 10% penalty can also be avoided if earnings are included in taxable income because either:
˃ The beneficiary receives tax-free scholarship or other educational assistance (other than a Pell grant)
˃ The qualified education expenses are used to claim the American Opportunity Tax Credit or the Lifetime Learning Credit
For the most part, only the very wealthy need to worry about the federal gift tax. If you are in that category, be aware that 529 contributions are considered “gifts” to the beneficiary for gift tax purposes. There are detailed rules and exceptions to this, so it is best to consult your tax professional for guidance.
Leftover Funds in a 529 Plan
If you find that there’s money in your child’s 529 account that won’t be used for education expenses, there are still tax-free options available for handling the funds.
- Leave the money in the account for the beneficiary’s education costs at any time. If there are no qualified expenses now, you can always wait to see if there are any later. You can withdraw the funds and pay the tax and penalty due if it doesn’t appear the beneficiary will need the money for education costs.
- Pay off student loans. Up to $10,000 of student loan debt counts as a qualified education expense.
It can also be used to pay up to $10,000 on the student loans of a sibling. The $10,000 limit is per beneficiary, not per year. Funds used to pay a sibling’s student loan debt counts toward the sibling’s $10,000 cap. If the beneficiary (or sibling) claims the student loan interest deduction, the deduction is reduced by any tax-free earnings from a 529 account used to pay their student loan. - Transfer the money to a Roth IRA. Up to $35,000 can be rolled over from a 529 plan to the beneficiary’s Roth IRA. Note that there are certain restrictions on this type of transfer, so again consult your tax professional.
- Transfer money to a family member’s 529 account. Unused 529 account funds can be transferred to a family member’s 529 account in two ways, without having to pay taxes or penalties.
a) withdraw the leftover money and deposit it in the family member’s account within 60 days, or
b) change the account beneficiary to the family member.
The family member must be the beneficiary’s:
- spouse
- · Child (natural born, stepchild, foster child, or adopted child), or a descendant of a child
- · Sibling (or stepbrother or stepsister)
- · Parent or ancestor of a parent
- · Stepfather or stepmother
- · Niece or nephew
- · Aunt or uncle
- · Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law
- · Spouse of any relative listed above
- · First cousin
Once the money is transferred, all the normal tax rules apply to the new beneficiary regarding use of funds for qualified education expenses.
- Transfer the money to a family member’s ABLE account. You can also transfer money from a 529 account to a family member’s Achieving a Better Life Experience (ABLE) account (a tax-advantaged savings account for people with disabilities).
Only so much money can be placed into an ABLE account each year (up to $19,000 in 2025).
A 529 transfer counts against the annual contribution limit.
Opening and Contributing to a 529 Plan
The fastest and easiest way to open an account is through the 529 plan’s website; you could also download a paper application from the website and mail it in. You’ll likely have to put a minimal amount of money in the account when you open it, and choose an investment option (e.g., age-based portfolios or individual fund options) that aligns with your risk tolerance and investment goals.
Once opened, make regular contributions, if possible, through automatic deposits directly from your bank account or paycheck into the 529 account. Some employers might also make contributions to a workers’ 529 account.