Section 529 plans are very popular educational savings accounts. They are solid savings vehicles that have many advantages to them, but this doesn’t mean that they are right for everyone. These programs are offered through individual states (making the issue more complicated since each state has its own plan rules). When planning for educational savings, think carefully about your situation, and consider the questions we listed last week.


Our goal today is to give you an in depth look at 529 plans and the advantages and disadvantages of these types of accounts. However, this is by no means all the information available, so make sure you do your own research before deciding which plan to invest in.



  • There are tax advantages to using 529 plans for education savings. When the money in a 529 plan is distributed to be used toward qualifying educational expenses (usually tuition, books, room and board, etc. – be sure to understand the definition before withdrawing any money), the distributions are completely tax free. Also, since 529 plans’ contributions are after-tax, you can withdraw your original contributions without being taxed again, no matter the reason.
  • 529 plans are counted as an asset of the owner of the plan, not the beneficiary, in the calculation for federal financial aid. So, if you are the plan owner of your child’s account and you are also seeking federal financial aid, the funds will only be counted for 5.6% as the parents’ assets, instead of 35% as the student’s assets. Also, since 529 plans can be owned by anyone, if someone other than a parent owns the account, it will not be considered at all in federal financial aid calculations.
  • 529 plan money can be used at a number of different educational institutions, not only colleges or universities. The simple answer would be that if the institution qualifies for the U.S. Department of Education federal aid program and is on the list of eligible schools, 529 plan money should be accepted there without tax consequence. Another way to look at it is if the school is accredited, you will most likely be able to use the funds at that school. However, each state’s program has its own rules, so be sure to know if the schools you and the beneficiary are considering are eligible before choosing a plan.
  • 529 plans are great to save for older students that are running out of time before needing the funds. There is no federal cap on contribution limits, and while each individual state imposes its own limit, they are usually very high. However, you are limited from a gift tax perspective. You can contribute up to the gift tax exemption ($13,000 in 2011, $26,000 for couples). You can also contribute up to 5 years of gifts ($65,000 for an individual, $130,000 for a couple) without triggering the gift tax into a 529 plan, as long as you don’t give any further gifting during the next 5 years. With the potential for such high contributions, 529 plans are often the best choice for late savers.
  • 529 plans are great estate planning tools. Due to the previous bullet point, and the fact that anyone can contribute to a 529 plan for the beneficiary, it can be a tool for family members (especially grandparents) to reduce their estate (and possible estate tax consequences). However, with the 5 year gift tax exemption, if the person who makes the contribution dies before the 5 years are up, the remaining year’s money will be returned to his/her estate.
  • The beneficiary of the plan can be changed to a relative of the original beneficiary without any tax consequence. So, if the original beneficiary decides not to pursue higher education or doesn’t use all the money available in the plan, then the beneficiary can be changed to a relative (just be sure to research who qualifies before you make a change). Also, there is no age restriction on 529 plans, so if you want to change the beneficiary to someone older who wants to return to school, you can do so, as long he/she is a relative.



  • While you have a choice in what state’s plan you choose, you have no control over the investments. There are different types of asset allocation available in the plans (a popular one being age based where investments become more conservative the closer the student comes to using the money). The only recourse you have if the investments are doing poorly in your chosen plan is to withdraw the money (which may have tax consequences – see below) or make a tax-free rollover into another state’s plan (once every 12 months). Since the plans often give no consideration to your own risk tolerance in investing, the account may be too aggressive or too conservative for your beneficiary.
  • Once funds are invested in a 529 plan, they can only be distributed for qualifying education expenses without tax consequence. If they are not, distributed earnings from the account are taxed at your income tax rate, and a 10% penalty is also charged on the earnings.
  • Because of the tax and penalty on earnings for distributions not used for qualifying educational expenses, if the beneficiary doesn’t use all the money in the plan, and you have no other beneficiary to which you can change to, you will have no choice but to withdraw the money and pay the tax and penalties.


Hopefully you saw something that will help! Please note that in this post we only discussed Section 529 Savings Plans. There are Section 529 Pre-Paid Tuition Plans which we will not discuss. Next week we’ll discuss Coverdell Education Savings Accounts.