How the account works
A 529 plan is an investment account sponsored by a state. You contribute after-tax dollars, choose from a menu of funds, and pay no federal tax on the growth so long as withdrawals go to qualified education costs: tuition, fees, books, required equipment, and room and board for students enrolled at least half-time. The law also permits limited use for K-12 tuition, apprenticeships and a capped amount of student loan repayment. You, the owner, keep control, and you can change the beneficiary to another family member at any time.
Choosing a plan
You may use almost any state's plan, and the school can be anywhere. Check your own state first, since many states give a deduction or credit on state income tax for contributions, and some require the home plan to get it. If your state offers nothing, shop on fees, because plans sold directly to the public are typically far cheaper than versions sold through advisors. Most plans offer age-based portfolios that begin mostly in stocks and shift toward bonds and cash as the enrollment year approaches.
What time does
Starting early matters more than the amount. As an illustration only, $200 a month from birth to eighteen totals $43,200 in contributions, and at a six percent average annual return, which is an assumption and not a promise, it would grow to roughly $77,000. The same $200 begun at age ten yields about $24,500 on $19,200 contributed. Relatives can contribute too. Large gifts fall under the annual gift tax exclusion, and a special rule lets a giver use five years of it at once.
If plans change
If the child wins a scholarship, you may withdraw up to that amount without penalty, paying only income tax on the earnings. If the child skips college, you can rename the beneficiary to a sibling, a cousin or yourself. Congress has also allowed leftover money to be rolled into the beneficiary's Roth IRA, within a lifetime cap and only from accounts open at least fifteen years. Otherwise, a non-qualified withdrawal means income tax plus a ten percent penalty on the earnings portion, never on your contributions. For financial aid, a parent-owned 529 counts as a parental asset, assessed at no more than about 5.64 percent of its value, which is far gentler than money held in the student's name.
Note Take withdrawals in the same calendar year as the expenses they pay, and keep the receipts. A December withdrawal for a bill paid in January is a common way to create a taxable mess.
