The 529 and College Savings

The 529 and College Savings

The 529 is a tax-advantaged college savings tool that can be extremely useful depending on a family's financial situation. 529s act like other investment accounts but they allow for tax-free withdraws for qualified education expenses. Much like a 401k or IRA, funds can be withdrawn for other purposes, but they will be taxed and penalized 10% in these cases. Think of it as a Roth IRA for your child's education expenses!

What is a qualified education expense?

In order for funds to be withdrawn tax-free, and without penalty, funds must be withdrawn and used for tuition, fees, books, or room and board at an "eligible" university. Additionally, recently tax changes now allow 529 funds to be used for lower education costs as well (up to $10k per year), making the 529 even more flexible. 

What are some other benefits of 529s?

If you are already taking advantage of other tax advantaged savings vehicles (401k, IRA, etc), then a 529 will give you similar tax advantages that you are familiar with. Some states have additional tax benefits (e.g. Illinois, Indiana, Iowa, Kansas) that will allow you to deduct your 529 contributions giving you even more tax advantaged savings. Indiana for example offers a 20% tax credit on up to $5,000 per year that can then be claimed against Indiana income tax (yearly maximum of $1,000).

Why wouldn't I use a 529?

Some families choose not to utilize 529s because they may not want to have their investments limited to educational expenses. Because, withdrawing from a 529 for anything other than educational expenses triggers a 10% penalty, families often defer to a traditional investment account for increased flexibility. Additionally, not all 529 accounts give the same investment options as traditional investment accounts, which turns off many investors. Not all states offer additional 529 tax benefits so the benefit may not be as beneficial in certain states.

How much do I invest in a 529?

This is one of the most difficult questions about 529 investing. Schools can vary in cost dramatically; in some cases they can be hundreds of thousands of dollars different! This makes saving in a 529 challenging for families because it is difficult to know what an appropriate amount is in order to realize the maximum tax benefit, while also covering the majority of college costs. College costs are constantly increasing at both private and public schools. A common conservative approach is to set a goal of covering expected tuition at your local state university as a baseline in a 529, and potentially set aside funds in a traditional investment account. If your child chooses a more expensive school, then use funds from the investment account to cover the delta. If your child goes to a less expensive school or does not have college costs to pay, the 529 can be transferred to a qualifying family member, such as another child, niece or nephew, or grandchild, while the additional funds in the traditional investment account can be used for early retirement.


At the end of the day the 529 is a great tool for saving for college. Some families actually appreciate the 10% penalty associated with the accounts because it makes them less likely to tap into as a rainy day fund, like they might with other investment accounts. This ensures that at least some part of your child's education funds are "safe." Because 529 beneficiary rules are so flexible, there should be little concern that the money is "stuck" in an inefficient investment when it comes time to withdraw. With the recent new updates to the tax code allowing funds to be used for lower education expenses, 529s are more flexible than ever and should be part of every family's portfolio, even if just a small piece.

Stephen N.
Stephen N.