What Is a 529 Account? How It Works and Tax Rules

A 529 account is a tax-advantaged education savings plan that lets money grow tax-deferred and can be withdrawn tax-free when used for qualified expenses like tuition, books, and supplies. 529 accounts are designed to help families save for the future cost of education. Your contributions are invested in portfolios that can include mutual funds, giving your money the potential to grow tax-deferred over time.

There are two main types of 529 plans: college savings plans and prepaid tuition plans. Both help families save for education, but they work differently.

This is the most common type of 529 plan. You contribute money to an investment account, and the funds can grow tax-deferred. When it's time to pay for education, you can withdraw the money tax-free for qualified expenses such as tuition, fees, books, and even room and board. These plans offer flexibility—you can use the funds at most accredited colleges, universities, and even some K–12 schools.

If you know your child will attend a public school in your state, a prepaid tuition plan lets you lock in today's tuition rates for future use. These plans typically guarantee coverage for tuition expenses and certain fees at in-state public schools. Some even include housing and meal costs (up to a limit based on the school’s cost of attendance). If your child attends an out-of-state or private school, prepaid funds can usually be transferred, but they often only cover the average in-state tuition cost. There's also a prepaid 529 option for a consortium of private colleges, which can help offset rising tuition costs at those institutions.

A 529 plan can be used for a wide range of education-related costs—but not everything qualifies. Here's an overview of what qualifies and what doesn't.

• K–12 tuition at elementary or secondary public, private, or religious schools (up to $20,000 per beneficiary per year).
• Tuition and fees for college, graduate school, certain vocational programs, eligible nondegree and credentialing programs tuition, and even some international schools approved by the U.S. Department of Education (no limit).
• Room and board for students enrolled at least half-time.
• Required books, online education materials, and supplies.
• Tutors or providers offering educational therapy to students with disabilities or special needs.
• Fees for standardized tests, such as admission or Advanced Placement exams.
• Costs for dual enrollment in college courses taken in high school.
• Computers, software, and internet access for school use
• Student loan repayment: Up to $10,000 lifetime per beneficiary

Withdrawals for non-qualified expenses will trigger taxes and a 10% penalty on earnings. Examples of non-qualified expenses include: 

• Transportation and travel
• Health insurance or medical expenses
• Sports or activity fees not required for enrollment
• Non-educational technology or personal electronics

Note: Not all states follow the federal definition of qualified expenses. Always check your plan documents and IRS Publication 970 before making a withdrawal to avoid surprise taxes or penalties.

If you use 529 funds for a non-qualified purpose, only the earnings portion of the withdrawal is subject to federal income tax and a 10% penalty.

• Federal taxes and penalty: Earnings are taxed as ordinary income, and the IRS applies a 10% penalty on those earnings.
• State tax considerations: If your state offered a deduction or credit for contributions, you may need to repay those benefits when making a non-qualified withdrawal.
• Penalty exceptions: The 10% penalty does not apply if the beneficiary receives a scholarship, attends a U.S. military academy, becomes disabled, or dies. Income tax on earnings still applies.

A 529 plan has two key roles: the account owner and the designated beneficiary.

• Owner: This is the person who opens and controls the account—often a parent, grandparent, or other family member. Owners can open a 529 through a brokerage, financial institution, or directly with a state. You'll also want to name a successor owner in case something happens to you.
• Beneficiary: This is the person whose education expenses the account will cover. It could be your child—or even an adult. A beneficiary can have multiple 529 accounts, but the combined contributions must stay within the state's limit.

A 529 plan offers several tax advantages that can make saving for education more efficient:

• Tax-deferred growth: Earnings grow without being taxed each year, which helps your savings compound faster.
• Tax-free withdrawals: Distributions are tax-free when used for qualified education expenses such as tuition, fees, books, supplies, room and board, and certain technology.
• Gift and estate tax features: You can contribute up to $19,000 a year ($38,000 for couples) per beneficiary without triggering federal gift tax. You may also contribute up to $95,000 ($190,000 for couples) in a single year by electing to spread the gift over five years for tax purposes. Additional contributions during that period may still avoid gift tax if you haven't used your full lifetime gift tax exemption ($15 million).
• High contribution limits: Most states allow large maximum account balances, often exceeding $300,000.
• No income limits: Anyone can contribute to or open a 529 plan regardless of income.

Contributions to a 529 plan are made with after-tax dollars and are not deductible on your federal tax return. However, some states offer additional tax benefits, which we'll explore next. 

All 50 states and the District of Columbia offer at least one 529 plan, and you can generally open an account in any state and use the funds nationwide. However, state tax rules vary, and this can impact which plan makes the most sense for you. It's a good idea to carefully consider your state's tax state rules before choosing a plan.

Many states offer a tax deductions or tax credits when you contribute to their own in-state plan. For example, New York offers a state income tax deduction for contributions to the New York 529 plan. In states like this, starting with your home state's 529 plan often provides the greatest tax advantage because most states require you to use their plan to qualify for the benefit.

If you live in a state with no income tax—such as Texas or Florida—you will not receive a state tax deduction for 529 contributions. For many families in these states, comparing plans based on factors such as fees, investment options, and plan features becomes more important than state tax treatment.

Some states—such as California, Kentucky, New Jersey, and North Carolina—charge income tax but do not offer a deduction or credit for 529 contributions. For residents of these states, there is no state-tax incentive to stay in-state.

A small number of states (Arizona, Arkansas, Kansas, Maine, Minnesota, Missouri, Montana, Ohio, and Pennsylvania) allow residents to claim an income tax deduction for contributions to any 529 plan, not just their own state's plan. This gives families the freedom to choose the plan that best fits their needs without losing state tax benefits.

Because state rules differ widely, it's important to review your state's guidelines or consult a tax professional if you're unsure how state taxes may affect your decision. State tax rules can also change from year to year, so be sure to review the most current guidance when comparing plans.

Most 529 plans allow you to open an account with a small amount—say $25 or $50 a month—if you sign up for an automatic investing plan, with the 529 plan contributions coming directly from your bank or brokerage account. Some employers allow you to make 529 plan contributions automatically as a payroll deduction, so be sure to check if your company offers that benefit.

When you open a 529 account, you'll decide how the money is invested. Most plans offer two main approaches: target-date portfolios or static allocation portfolios.

Target-date portfolios are designed to automatically adjust over time, starting with a more aggressive allocation when the beneficiary is young and gradually shifting to conservative as college approaches. 529 plans typically offer:

• Enrollment-year portfolio: The target date is based on the year the student expects to start school or begin using the funds.
• Age-based portfolio: The target date usually aligns with the beneficiary's 18th birthday, but this isn't universal.

These options tend to be ideal for families who prefer a hands-off approach, as the portfolio rebalances automatically.

These keep the same allocation until you decide to make a change (typically allowed twice per calendar year), giving you more control of investment decisions.

Saving for college is a wise move, even if a child may qualify for financial aid—especially considering that most financial aid comes in the form of loans, which must be repaid with interest.

Here's how a 529 account factors into financial aid calculations:

A 529 plan owned by a parent (or by the student as a dependent) is treated as a parent asset on the Free Application for Federal Student Aid (FAFSA). This means a maximum of 5.64% of the account value is considered in the expected family contribution—far less than the 20% assessment applied to student-owned assets.

These accounts are not reported as assets on FAFSA. Withdrawals from a grandparent-owned 529 plan do not count as student income.

About 400 colleges use the CSS/PROFILE^®, which may assess 529 assets differently. Parent- and grandparent-owned 529 plans may be considered in the institutional formula, depending on the school.

Note: 529 plans do not affect merit-based aid, including academic or athletic scholarships.

Saving for education is a big decision—and the right strategy depends on your savings goals, timeline, and tax situation. We recommend reviewing your options with a financial planner and a qualified tax advisor. They can help you determine if a 529 plan fits best with your overall financial plan and investment objectives.