What Is a 529 Plan and Does My Child Need One?

A 529 plan, also known as a “qualified tuition plan”, is a college savings/payment plan with some tax benefits associated with it. These benefits vary by state and can be drastically different. The good news is that you can use any state’s 529 plan – though there are some downsides to this. These plans can be great for planning your children’s future college expenses. So, if you’re looking to plan out your future scholar’s college funding, this is a great place to start.

About the Plan

The 529 plan offers tax-deferred growth in the investments held within the plan. So, you are not charged taxes on the dividends, interest, or sales of securities within the plan. There are two types of plans: a pre-paid tuition plan or a college savings plan. Almost every state has at least one 529 plan option available to choose from. You can also find some 529 plans run by private universities and colleges.

Type One: The Pre-Paid Tuition Plan

If you go with the pre-paid tuition plan, the account holder is allowed to buy units or college credits at participating college and universities within the plan. Most of these tend to be public universities or in-state colleges. The best part about this plan is that you are paying today’s costs and not inflated future prices.

Though there are some shortfalls with this plan. One of these is that the plan doesn’t pay for room and board. One of the other big concerns is that if the child not to go to a participating school, then you might only get a fraction of what you put into it. This also goes for the child choosing not to attend college at all. Also, most plans are sponsored by states and are not backed by the federal government. So, if there is an issue with the plan you may only get back a portion of the money that you had put in.

Type Two: College Savings Plan

This type of account allows the person saving for the beneficiary to open up an investment account for the beneficiary’s future schooling expenses – this time including room and board. Withdrawals of the money can be used at generally any college or university, ranging from public, private, or religious elementary schools to college.

The account allows the saver to invest in various mutual funds, ETF portfolios, and bank products. The risk level of these investments is up to the saver. Though, they typically follow a somewhat conservative adjustment as the beneficiary drawers closer to age when they will be attending the school that the plan is set to pay.

These plans are not state or federally guaranteed, as the money is generally invested in securities. Some of the bank products may be federally covered by the FDIC, though. Some of them have residency requirements to participate in the plans. This can be either for the beneficiary or the saver of the plan.

How Does This Affect My Taxes?

Some 529 plans offer special tax benefits for contributions. Each of theses benefits vary by state. I live in the state of Rhode Island, which allows me to deduct $500 from my state taxable income. If you live in Rhode Island and file jointly with a partner, you can deduct up to $1,000.


For withdrawals, if you are using the funds for a college expense, then the earnings made in the fund are not subject to federal taxes. This can be true in the case of state taxes, as well – but again, this depends on the state. If you take money out of the account without designation towards an educational expense, then it will be subject to state and federal income tax along with a 10% penalty for withdrawal.

Some Restrictions and Effects

The 529 plan does come with some caveats, which is why you should read up on the plan before investing. Many plans have pre-set investment options to choose from and you will most likely only be able to change the investment options twice a year. Though, if there is a change in beneficiary then you will be able to change those options.

You can only withdraw money set for qualified higher education expenses and secondary/elementary school tuition, as well. If you are using a tuition payment plan and your children decides not to attend a participating college or university, then they might only get a fraction of the credits payed that they would have gotten at a participating school.

Investing in a 529 account will impact a student’s eligibility for need-based financial aid from a college or university. Though, each institution will treat the assets in a 529 account differently for eligibility. So, you should consider how having a 529 account ay affect your future student’s ability to pay for college. Will this account be paying for all of it? If not, how will they pay for the rest of their time in a college or university?

Overall Benefits of the Plan

This plan will give you some options when it comes to paying for school, especially if you are starting early for a child. The plan covers not just the tuition and expenses but could also cover room and board costs. You will get tax advantages and, depending on which state you live in, you plan to choose possible tax write-offs. This plan is flexile and can be used for elementary, secondary, or higher education.


Bottom Line

There are so many benefits to using the 529 plan and it can truly have a positive effect on your child. It can really reduce his or her stress when it comes to repaying their student debt. A major benefit to using one of these plans is all of the tax savings you may potentially receive from investing in the plan. The plan also offers many liabilities that each family may be able to use, so I would recommend talking to a tax professional about how this could help you.

Though, if your child does not attend college, you may only be able to receive a fraction of the value of the plan. Also, the money withdrawn will incur a tax payment, as well as penalties, if used for non-educational purposes. Have no fear, though, you will get some money back and if you have another child, you can roll it over to them as the new beneficiary of the plan.

Overall, I believe this plan could work well for many families, but not always everyone. I would definitely consider talking to a tax professional or financial advisor – a fiduciary is often preferred. If you would like to learn more, I recommend checking out 529 College Savings Plans for Grandparents – 2019-2020 Edition by Jeffrey J. Pritchard, which is a comprehensive look at the plan and its overall benefits for your child and family.



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