529 college savings accounts are one of the best ways to save and invest for your children’s future college expenses. 529 plans are offered by 49 states plus the District of Columbia. These tax-advantaged accounts allow your investments to grow without capital gains taxes, provide tax-free withdrawals for qualified education expenses, and they can even offer some state income tax deductions for residents of certain states.
With the cost of college skyrocketing year after year, many families might feel overwhelmed. It might seem impossible to pay for future college tuition costs. The truth is: 529 plans can help. Depending on your child’s age and your personal finances, you still might have time to save a meaningful amount of money in a 529 plan.
Let’s look at a few of the biggest misunderstandings about 529 plans, compared to the reality of saving for college.
1. Myth: It’s too late to open a 529 plan after your child reaches a certain age
Reality: It’s never “too late” to save for college in a 529 plan. Even if your child is already a senior in high school, you can still put money into a 529 account. Or if your student is already attending college, some states allow you to put money into a 529 plan and withdraw money to pay for college expenses in the same year.
2. Myth: You get a federal tax deduction for 529 plans
Reality: Sorry, there is no federal tax break for putting money into 529 plans. These plans are managed by state governments, so each state gets to decide whether to offer a state-level income tax break. And some states like Florida and Texas don’t have state income taxes.
Some states that have income taxes will allow residents to get a deduction for the money contributed to a 529 plan. But even in states that charge state income taxes, you’re not guaranteed to get a tax break for your 529 contributions. For example, California does not provide any state tax deductions for contributions to California’s ScholarShare 529 plan. But my home state of Iowa does.
3. Myth: 529 plans can only be used for four-year colleges and universities
Reality: You don’t have to go to a four-year school or an in-state school. The money saved in a 529 account can be used to pay for a wide range of private or public higher education programs, including two-year community colleges, vocational programs, some apprenticeships, and some international institutions.
Check with your state 529 plan to make sure your child’s chosen school or education program is accredited and eligible for U.S. Department of Education student aid programs. Qualified education expenses for 529 money include tuition, books, fees, technology and software, some room and board expenses, and up to $10,000 of the account beneficiary’s loans for education.
4. Myth: 529 plan money is “use it or lose it”
Reality: Even if your child chooses not to go to college or pursue eligible vocational training, you still have options with your 529 plan money. Here are a few options for unused 529 funds:
- Switch the 529 plan to the name of a different beneficiary in your family (such as the beneficiary’s sibling, parent, first cousin, or future child).
- Withdraw the money for non-qualified education expenses — but you will have to pay complicated tax penalties: a 10% federal tax penalty plus federal income taxes on the plan’s earnings. If you got a state tax deduction for your 529 contributions, you might also owe extra state income tax in case of non-qualified withdrawals.
- Roll over the money into a Roth IRA under your child’s name — this is a new rule starting in 2024, but it’s limited to $35,000 of money and your 529 plan must have been open for at least 15 years. You can roll over the full IRA contribution limit per year ($7,000 for 2024) for a maximum of $35,000, or until you deplete the 529 account.
5. Myth: Only parents can put money into a 529 plan
Reality: Anyone can open a 529 plan for any beneficiary. Parents are likely to do the heaviest lifting when saving for college, but grandparents can open a 529 plan for their grandchildren too. Family members and friends are also welcome to open a 529 plan for their favorite future college student, or contribute money to a 529 plan owned by someone else.
In this way, 529 plans are a flexible way to team up with your loved ones to help save for college. But check with the rules for your state’s 529 program. If you want a state tax deduction, in some states, you might need to be the 529 account owner, not just contribute to your family member’s account.
Bottom line
529 plans are a flexible, tax-advantaged way to save and invest for college for your child or other loved ones. You won’t get a federal income tax deduction in the same way as a traditional IRA, but you can get tax-free investment growth. And as long as you use the 529 account money for qualified education expenses like tuition and room and board, you won’t owe any taxes on the withdrawals.
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