Part 4: Where to Save for College
We know how much we need, when we need it and how much we need to save each month to get there. Now let's explore which accounts to save in and what to invest in to maximize.
Quick recap: You've calculated your target amount, adjusted for inflation, and determined your monthly savings goal. Now it's time to choose the right savings vehicle.
What Is a 529 Plan?
A 529 plan is a tax-advantaged savings account specifically designed to help families save for future education costs. Named after Section 529 of the Internal Revenue Code, these accounts allow your investments to grow tax-free as long as the money is used for qualified education expenses.
There are no income limits to participate, and nearly every state offers at least one 529 plan. Some states also provide tax deductions or credits for residents who contribute.
Why Use a 529 Plan?
The core advantage of 529 plans is tax efficiency. In comparison to a taxable brokerage account your money grows tax-free. When the money is used for qualified education expenses, you won't owe taxes on the gains. Many states also offer additional tax deductions or credits for contributions.
529 Tax Savings Calculator
How 529 Plans Work
- • You contribute after-tax dollars (no federal tax deduction)
- • Funds are invested in mutual funds, ETFs, or age-based portfolios
- • Earnings grow tax-free while invested
- • Withdrawals are tax-free if used for qualified education expenses
- • No income limits on who can contribute
- • High contribution limits (often $500k+ per beneficiary)
529 Plan Pros and Cons
Pros
Tax-Free Growth
No taxes on investment gains when used for qualified expenses
State Tax Benefits
Many states offer tax deductions or credits for contributions
High Contribution Limits
Can save $300k-$500k+ depending on state
Flexible Beneficiary
Can change beneficiary to other family members
Estate Planning Benefits
Contributions reduce your taxable estate
Cons
Limited Use
Must be used for qualified education expenses
Penalties for Non-Education Use
10% penalty + taxes on earnings if used for other purposes
Limited Investment Control
Can only choose from plan's investment menu
Financial Aid Impact
Counts as parent asset on FAFSA (5.64% assessment rate)
Market Risk
Investment value can fluctuate with market conditions
What If You Don't Use It for College?
Life is unpredictable and there are scenarios where you might not need the money for college. In these scenarios you can:
- Change the beneficiary to another qualifying family member
- Use the funds for other educational purposes, including K–12 tuition or graduate school
- Roll over up to $35,000 into a Roth IRA for the beneficiary (subject to specific rules)
- Withdraw the funds for other uses—earnings will be taxed as income and subject to a 10% penalty
Note: The 10% penalty and income tax only apply to the earnings portion of the withdrawal. Your original contributions can always be withdrawn tax- and penalty-free.
Next: Making It Happen
Now we know what a 529 plan is, how it works, and its pros and cons. In the next part, we'll look at different states' 529 plans and how to choose the best one for your needs.
Coming Up in This Series
- Part 5: Which 529 Plan is Best?
- Part 6: Balancing College & Financial Independence