Named for a section of US tax code, 529 plans are tax-advantaged savings accounts used to pay for qualified education expenses. The plans are sponsored by a state or educational institution.
Though 529 plans are typically associated with parents saving for their children to go to college, any adult can open a 529 plan and use the account to save for the education expenses of family members, friends, or even themselves.
With college becoming increasingly unaffordable—tuition has increased more than 600% over the last 40 years, which is three times the rate of inflation—students have turned to loans to pay for their education, racking up roughly $39K of debt on average for a total national debt pile of $1.77T.
The climbing cost of tuition has left more parents and other savers seeking out ways to pay for education, including 529 accounts. As of 2024, there were roughly half a trillion dollars in 529 plans across the US.
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Roth IRAs and 529 plans both offer tax advantages, but they serve different goals. 529s are state-run accounts meant for education, offering tax-free growth and withdrawals for qualified expenses. Roth IRAs are built for retirement, but can also be tapped for education, with more investment flexibility and fewer contribution limits.
Investors put after-tax dollars into these education-earmarked accounts, and like a 401(k) or IRA, they invest them into stocks, bonds, or funds. When it comes time to withdraw, investors do not pay any taxes on distributions. However, the money must be used for approved expenses like college tuition, textbooks, and trade schools.
To cover the cost, students turn to a variety of sources. Parental contributions plus savings funds cover about half of the expenses on average, with students relying on other sources—typically federal aid, in the form of scholarships and loans—to cover the rest.
One of the key disadvantages of a 529 college savings plan is the possibility a beneficiary doesn’t end up going to college. Nonqualified withdrawals are subject to a 10% penalty. However, as of 2024, the SECURE Act 2.0 started allowing 529 savers to roll over $35K into a Roth IRA.
The tax-advantaged accounts can be used to pay for K-12 education, apprenticeship programs, and student loans, in addition to their original purpose: paying for college. But 529s have downsides, such as fees and penalties for non-qualified uses.
Parents can open a custodial Roth IRA when their child starts to earn income (think: summer job), which can help them start saving early. For example, 529 accounts help parents save for college, while UTMA/UGMA accounts function like trusts.
Income affects FAFSA financial aid determinations. FAFSA also takes 529 college savings plans into account. The percentage of savings it uses in its calculations depends on who owns the account (parent, student, or someone else). Other schools use a program called CSS to determine financial aid, and those determinations vary.
The cost of attending college has outpaced inflation in the US. Tuition has climbed more than 600% in the past 40 years; more than three times the inflation rate. Many students have racked up student loans to cover rising college costs, while others have chosen not to attend college altogether.
The parent explains the basics of what a 529 is, its advantages, and how it works, breaking down portfolio options for investing in 529 plans using Vanguard as a provider.
A podcast listener asks about contributing to a 529 savings plan for their friend’s child. The hosts go over the basics of what a 529 is and how it works, and then give advice on how the listener can contribute, touching on how to have conversations about money with friends.
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