What's a 529 college savings plan?

Last updated: January 1

The cost of a college education keeps getting higher and higher, even outpacing inflation. According to the National Center for Education Statistics, prices for undergraduate tuition, room and board at public institutions rose 42 percent from 2001-2011 compared to a 31 percent increase in prices at private not-for-profit institutions.

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Fortunately, planning and saving ahead of time can help parents contribute to their children's education without sacrificing their retirement plans. A 529 college savings plan is a popular savings vehicle that is generally state-sponsored and professionally managed. In some cases, you can automatically contribute money from each paycheck, similar to the way you might contribute to a retirement savings account such as a 401(k).

Each state has at least one 529 plan, and many offer several options. You're not limited by your state of residence or the state where your child plans to attend college, but some states offer benefits for residents who invest in their state's 529 plan.

Here's a look at the benefits of using a 529 plan to save for college:

  • Flexible use.
    Money in a 529 plan can be used to pay for eligible expenses such as tuition, fees, textbooks, computer equipment (if required) and room and board. There are generally no penalties for rolling over funds to a different beneficiary, so [SJ4] you could transfer money not used by one child to another relative. There are no age limits or requirements, so you could start a 529 for an adult child or even for yourself if you decided to go back to school.
  • Potential tax benefits.
    Assuming you use withdrawals for eligible college expenses, earnings in a 529 plan are generally not subject to state or federal taxes. However, withdrawals for other purposes might be subject to tax. Some states also offer matching grants for investing in a 529 plan, but you may need to participate in the plan offered by your state of residence to receive the grant.
  • Menu of investment options.
    The person who opens the account (also called the account holder or custodian) typically chooses the investment options, in which the plan invests on their behalf. These options might include stock mutual funds, bond mutual funds, and money market funds. Or, in the case of an age-based 529 plan, money would be invested more aggressively at first to jump-start growth and gradually become less risky as the beneficiary (the child the money is intended for) approaches college age.
  • Contributions from friends or relatives.
    Although you might be the custodian of the 529 plan and choose the investment options, friends or relatives can contribute to your child's 529 plan and help that money grow over time.