Section 529 Savings Accounts

Paying for higher education is often a challenge. One option is a 529 Savings Plan, or as the IRS calls it, a Qualified Tuition Program (QTP). Parents and students save for college or other accredited schools with this savings account.

What's a 529 Plan?

A 529 Plan is created by a state, a state agency or an eligible educational institution allowing the purchase of tuition credits or contributions to an account to meet the education expenses of a specific person or "beneficiary." The person who opens the account is the "owner." Usually the owner is a parent like you and the beneficiary is your child. However, it's possible for the owner and beneficiary to be the same person, such as when an adult wants to return to school.

In order for your child to be able to use money in a 529 account, her school must meet established guidelines, but generally it can be any college, university, vocational school, or other postsecondary educational institution eligible to participate in federal student aid programs.

A 529 Plan set up by an educational institution typically holds your investment in special trust account. These programs must also meet various requirements established by the IRS, such as having set procedures for deposits, managing the QTP, investing contributions, and accounting or bookkeeping.


As a general rule, neither you nor your child have to pay any federal or state income taxes on any money earned in a 529 account or on any money taken out of it (called a "distribution"). As long as the money is spent on the student's qualified higher education expenses, there are no taxes. These expenses include:

  • Tuition and fees
  • Room and board (so long as the student is at least enrolled as a half-time student)
  • Books, supplies, and equipment

If a distribution is used for something other than a qualified expense, or if there's more money in the account than what's needed for qualified expenses, the money earned by the 529 is taxable. You, as the account owner, are usually responsible for paying the taxes. Also, in most cases, the IRS will tack on a 10 percent penalty. You may not have to pay the taxes or penalty, however, if the student:

  • Dies and you give the distribution to another beneficiary
  • Becomes disabled
  • Gets a scholarship 

What about gift taxes? As a general rule, in 2010, you can give $13,000 to your child as a gift without having to worry about taxes. If you go over that amount there may be tax bill for you and your child, though. A 529 account can help you here. You can make a contribution over the limit but spread it out over five years to avoid the gift tax problems. It can be a very effective estate planning tool.

For example, in 2010 you can deposit $65,000 in your child's 529 account. For gift tax purposes, the contribution is treated as five separate, yearly $13,000 contributions, and so no gift tax liability. However, you can't give your child any more gift money - whether it's put into the 529 or not - during that five year period. If you do, the gift is taxable and you have to report it.


Pros and Cons of a 529 Account

Aside for the tax pros and cons listed above, a 529 savings account has other advantages disadvantages.

On the plus side, you can save for your child's or your own post-secondary education by putting money in the savings account. When the student is ready to attend college or any other post-secondary school, you could have a nice sum set aside for tuition and expenses. It can go a long way toward limiting the "sticker shock" that comes with a tuition bill.

Also, in 529 Plans that invest your money (as apposed to plans where you but tuition credits), you get the benefit of having your investment managed by financial experts.

Last but certainly not least, in many states, you get a state tax deduction or credit for some of your yearly contributions to a 529 Plan. Check your state's tax laws to see if and how much of a deduction or credit you're entitled to. Sorry, you don't get a federal tax credit or deduction.

A 529 account also has disadvantages. The state, state agency or educational institution that set up the plan determines how the plan's money is invested. You, as the account owner, can't do much more than select one of the investment strategies created by the state, agency or school. Or, you may be able to choose from a list mutual funds pre-selected by the state, agency, or school.

Also, there's no guarantee your investment will make money, and it's possible to lose money. You should talk to your financial advisor about the investment risks.

If there's any money left over in the account after your child graduates, it may be taxed and subject to the 10 percent penalty. Likewise if there's money in the account when your child turns 30 years old. If that happens, taxes can be avoided by rolling the money into a new 529 account, though.

Finally, a 529 account is counted as an "asset" by the federal financial aid officials when calculating the Expected Family Contribution, (EFC), that is, how much of the tuition your expected to pay. So, the 529 account may lower the amount of federal financial aid your child is eligible to receive.  

Without question, a 529 account provides some assurance that your child will be able to afford college, while at the same time giving you some tax advantages. The downside shouldn't be ignored, though. Before investing in a 529 Plan, do some careful research. If you have any questions, talk to a tax lawyer or financial advisor to make sure you're making the right decision for you and your child.

Questions for Your Attorney

  • How can I tell if an educational institution is eligible to set up a Qualified Tuition Program, and can a program lose its eligibility?
  • If my § 529 savings account is with a state agency, do I have to send my child to a school run by the same state?
  • Will having money in a § 529 savings account affect the amount of money I can get for financial aid from a school?
  • Can I change the beneficiary of § 529 account, for example if I want to apply unused funds to a younger child's tuition once my older child finishes school?
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