How 529 Plans Help Manage Costs and Maximize Education Savings

The cost of higher education in the United States has been steadily increasing. This places a significant financial burden on students and their families. In the 2024-25 academic year, the average tuition for full-time in-state students at public four-year institutions rose to $11,610, marking a $300 increase from the previous year, a 2.7% rise before adjusting for inflation. Families need to adopt effective savings strategies to manage these escalating expenses.

Among the most impactful tools for addressing this challenge is the 529 plan. These plans offer a tax-advantaged way to save for education expenses, enabling contributions to grow tax-free and make tax-free withdrawals for qualified expenses. 529 plans help families bridge the gap between rising costs and education funding goals. A financial advisor can help explain 529 plans and recommend ways to maximize your savings and reduce education costs.

This article explores the key features of 529 plans, their advantages, and practical strategies for using them to manage education costs effectively.

Understanding 529 plans

A 529 plan is a specialized savings account created to help families manage the financial demands of education. Designed to encourage education savings, 529 plans offer tax benefits making them a popular choice for families planning for future academic expenses.

Below are the main types of 529 plans, each of which serves a specific purpose:

1. 529 college savings plans

Named for a section of the Internal Revenue Code (IRC), 529 plans are tax-deferred savings plans designed to help pay for college expenses. Families can contribute after-tax dollars, which are invested in a preset selection of investment options, usually mutual funds and ETFs. Importantly, any earnings from these investments are not taxed, and withdrawals remain tax-free as long as they are used for qualified educational expenses such as tuition, room and board, books, and supplies.

2. Prepaid tuition plans

Prepaid tuition plans allow families to lock in current tuition rates at specific colleges or universities and shield them from future inflation. These plans are ideal for those confident in their choice of institution and location, as they often come with limited flexibility. Many prepaid plans have residency requirements and may restrict their benefits to in-state public colleges or a specific network of schools. Do note that prepaid tuition plans do not cover room and board costs.

3. Betterment 529 plan

Families that seek a modern, tech-enabled approach to education savings can use the Betterment 529 plan which provides a simplified and automated investment solution. These plans leverage low-cost investment options and personalized portfolio management to streamline the process of building and managing a 529 college savings plan. It offers a user-friendly platform that helps minimize the complexities often associated with investment planning.

Benefits of 529 plans

529 plans offer several benefits, making them a highly effective tool for managing education savings. These advantages extend beyond just financial growth, encompassing tax savings and unparalleled flexibility to accommodate the diverse needs of families and students.

1. Tax advantages

• Federal tax-deferred growth: Earnings within a 529 plan grow on a tax-deferred basis, meaning families are not taxed annually on investment gains. Over time, this allows contributions to accumulate more quickly than taxable accounts.
• Tax-free withdrawals: When funds are withdrawn for qualified educational expenses, such as tuition, room and board, or books, they are not subject to federal income tax. This further amplifies tax savings.
• State tax benefits: Many states offer additional tax incentives for contributing to their 529 plans. Depending on the state, families may be eligible for deductions or credits on state income taxes, providing even more value. However, the availability and extent of these benefits vary, so it’s crucial to understand the specific rules of your state’s 529 program.

2. Increased flexibility

529 plans are designed with flexibility in mind. They can accommodate a variety of educational and family scenarios. Funds in a 529 plan can be used for various educational costs, including tuition, room and board, textbooks, and supplies. Additionally, recent changes in regulations allow 529 plan funds to be applied to certain K-12 education expenses and even apprenticeship programs.

Another feature that adds to their utility is the transferability of 529 plans. Suppose the designated beneficiary does not need the funds due to receiving a scholarship or choosing a different path. In that case, the account owner can transfer the funds to another family member without penalty. This flexibility ensures that the savings remain within the family.

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Limitations and considerations of 529 plans

While 529 plans are highly effective for education savings, it’s essential to understand their limitations and plan accordingly to avoid potential pitfalls.

1. Penalties for non-qualified withdrawals

The primary purpose of 529 plans is to fund education. If the funds are withdrawn for non-qualified expenses, the earnings portion of the withdrawal is subject to federal income tax and an additional 10% penalty. These penalties apply, for instance, if funds are used to pay for non-educational personal expenses or transportation that are not considered qualified educational expenses.

There are specific circumstances where the penalty may be waived. If the beneficiary receives a scholarship, the amount equivalent to the scholarship can be withdrawn without the 10% penalty, though the earnings will still be subject to income tax. Other exceptions include the death or disability of the beneficiary, which allows for penalty-free withdrawals.

2. Impact on financial aid

Parent-owned 529 plans are treated as parental assets in the Free Application for Federal Student Aid (FAFSA) calculation. This means up to 5.64% of the plan’s value may be reduced due to the student’s eligibility for need-based financial aid.

Plans owned by other relatives, such as grandparents, can have a more significant impact. While these accounts are not initially considered in FAFSA calculations, withdrawals are treated as untaxed income for the student in subsequent years, which can reduce financial aid eligibility by as much as 50% of the withdrawal amount.

3. Overfunding risks

Overfunding a 529 plan can result in excess funds that may be difficult to use without incurring penalties. If the beneficiary doesn’t use all the funds for qualified expenses, the remaining balance may attract penalties and taxes when withdrawn.

Unused funds can be transferred to another family member, such as a sibling, without penalty, provided the new beneficiary is a qualified family member. However, careful planning and estimation of education costs can help avoid overfunding from the outset.

Below are a few key financial strategies for effectively using 529 plans:

1. Understand and maximize 529 plan contribution limits

• Federal gift tax rules and annual limits: Contributions to a 529 plan are considered gifts for federal tax purposes. In 2025, individuals can contribute up to $19,000 per beneficiary annually without triggering gift taxes up from $18,000 in 2024. The annual gift tax exclusion for married couples is set at $38,000 for 2025, up from $36,000 in 2024.
• The “superfunding” strategy: For high-net-worth individuals, a unique provision allows for “superfunding” a 529 plan. This enables contributors to make up to five years’ worth of gifts in a single year i.e. up to $90,000 for individuals in 2024 or $95,000 in 2025, without incurring gift taxes, provided no additional contributions are made to the same beneficiary during the following four years.

2. Utilize 529 plan catch-up contributions when starting late

• Late saving strategies: For families who start saving later, maximizing annual contributions and leveraging investment options with higher growth potential can help compensate for lost time.
• Opportunities for relatives: Grandparents and other relatives often play a critical role in education funding. They can make direct contributions to a 529 plan or use the super funding provision to provide substantial support.

Families should prioritize their financial security while planning for education. Using 529 plans in conjunction with retirement accounts, such as IRAs or 401(k)s, can help balance these goals. A 529 plan should be integrated into a comprehensive financial strategy that considers tax implications, expected college costs, and other long-term savings objectives.

3. Select the right 529 plan for your specific needs

• Assess tax benefits: Many state-specific plans offer tax deductions or credits for contributions, providing immediate savings. You can opt for a suitable plan among these to save on taxes.
• Look at the fees: Opt for plans with low administrative and investment fees to retain more of your contributions for education expenses.
• Evaluate investment options: Look for plans with diverse investment choices that align with your risk tolerance and the time horizon before college expenses.

You may compare in-state and out-of-state plans to find the best fit. While state-specific tax benefits are enticing, some out-of-state plans may offer better investment options or lower fees.

To conclude

The rising costs of education pose a significant challenge for families. They must, thus, adopt effective savings strategies to ensure value education without compromising on other financial goals. 529 plans provide a structured, tax-advantaged solution to meet these financial demands, enabling families to save and invest specifically for educational expenses.

Consulting a financial advisor can be invaluable in selecting the right plan, maximizing contributions, and taking full advantage of available tax benefits. With thoughtful planning, 529 plans can turn the rising costs of education into a manageable goal and strengthen a family’s ability to build a solid foundation for education savings.

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