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What is a 529 Plan and Which Ones Are the Best?

Paying for College

A 529 plan allows you to save money to pay for college expenses. Here's what you need to know about 529 plans

Updated on May 20th, 2024

One of the best ways to save for college for your student is a 529 college savings plan. A 529 plan allows your family to sock away cash to pay for future educational expenses. Plus, your investment grows over time, usually at a rate that significantly beats traditional savings accounts.

Scholarships are a great way to make any college more affordable. If you and your student want to learn about how to find and land scholarships, sign up for our free college scholarship webinar! Take a quick trip over to http://thescholarshipsystem.com/freewebinar to reserve a spot today.

However, figuring out the best 529 plans isn’t always easy. Luckily, there are ways to separate the okay options from those at the top. If you are wondering what a 529 plan is and which is the best 529 plan for you, here is what you need to know.

What is a 529 Plan?

To put it simply, a 529 plan is a savings vehicle designed specifically for educational expenses. They come with tax advantages when used for their intended purpose, which includes paying for college. Plus, they earn returns that more closely resemble other investment accounts, making them potentially more lucrative than a traditional savings account.

These investment options were named after the Internal Revenue Code’s Section 529. Created in 1996, the section allowed “qualified tuition programs” to achieve tax-free status, ensuring earnings were tax-deferred, and distributions were not taxed on the federal level when withdrawn for qualifying educational expenses.

Unlike traditional investment accounts, 529 college savings plans are run at the state level. However, that doesn’t mean you can only choose from those offered by your state. In fact, you can explore any that don’t have residency restrictions, allowing you to find the best 529 plan for your needs.

Every state offers at least one 529 plan. However, they don’t all work the same way. Usually, each plan falls into one of two categories: prepaid tuition plans or education savings plans.

A 529 plan allows you to save money to pay for college expenses. Here's what you need to know about 529 plans

What is a 529 Prepaid Tuition Plan?

Prepaid tuition plans allow students and their families to buy credits or units that can cover tuition and fee costs at participating colleges and universities. These 529 plans give you the ability to purchase the credits based on today’s prices instead of what college may cost in the future. This may or may not work in your favor since, if the cost of college goes down, you don’t get any money back.

Many prepaid tuition plans do have residency requirements, either for the saver or the beneficiary (the student who will be going to school). Additionally, your student might not be able to use this option to pay for other expenses, such as room and board, equipment, or supplies.

What is a 529 Education Savings Plan?

When people envision a 529 plan, they are usually picturing the education savings plan version. Education savings plans are more flexible than prepaid tuition plans — these function like investment accounts.

What are the best 529 plans?

Typically, the saver chooses between a range of investment portfolio options, like mutual funds or exchange-traded funds (ETFs). Any returns on the investments are deposited into the account, possibly helping it grow over time.

Like all investment accounts, these 529 plans come with a degree of risk. Your student’s portfolio may not experience gains and could even suffer losses. Before you open an education savings plan, you and your student need to determine how much risk you are comfortable with and select options that align with your preferences. Additionally, diversification is a must, as this prevents all of your proverbial eggs from being in one basket.

It is easier to use a 529 education savings plan for a wider range of purposes. For example, your student can use 529 education savings plans at almost any college or university in the country, and a broader selection of expenses can be covered with the money. Residency requirements for opening an account are also less common, so you might be able to look at programs in other states.

What Can I Use My 529 Plan to Pay for?

Prepaid tuition 529 plans are fairly limited, covering only tuition and certain mandatory fees. That’s why many people consider the education savings plan version the best 529 plan when compared to the alternative.

With the education savings plan, the money can also go to tuition and fees, just like a prepaid tuition plan. However, it can also cover much more, including:

  • Room and board
  • Off-campus housing (up to an amount equal to the cost of room and board on campus)
  • Books and supplies (only if they are required for your student’s classes)
  • Computers and software (when required as part of your student’s education)
  • Internet service
  • Special-needs equipment and special-needs transportation (eligibility is determined on a case-by-case basis)

Should I open a 529 plan?

There are a lot of common expenses that are not eligible under 529 plans. You cannot use a 529 plan to pay for the following without potentially incurring a penalty:

  • Transportation (non-special-needs)
  • Student loan payments or interest
  • Sports and activity fees or equipment (not related to a class)
  • Health insurance

Before using a 529 plan distribution for any expense, it is wise for your student to speak with the school to determine if the item is actually considered necessary for their education. Otherwise, it may not be considered a qualifying expense, and that can lead to a tax penalty.

What are the Penalties for Non-Qualified Distributions?

If your student takes a 529 plan distribution and uses the money for a non-qualifying expense, the financial consequences can be severe. If the distribution is made up of earnings (not original contributions to the plan), it is taxed at the ordinary income rate, and there could be an additional 10 percent penalty.

The saver can withdraw original contributions and not have to pay the penalty. However, that money is then taxed at the income rate, so there is a financial impact.

However, there are some non-qualified expense penalty exemptions too. For instance, if your student receives a scholarship, they might be able to avoid the 10 percent penalty for a non-qualifying 529 plan withdrawal, but might still have to pay income taxes on the money.

paying for college with a 529 plan

Since your student can use scholarships to free up 529 college savings plan money, striving to land scholarships is a smart financial move.

If you and your student want to learn more about scholarships for college students, attend our free college scholarship webinar! Head to https://thescholarshipsystem.com/freewebinar to sign up.

RELATED VIDEO: 529 College Plan: Getting Your Child To A Debt Free Degree

Which State Has the Best 529 Plan?

Since every state has at least one 529 plan available, figuring out which are the best 529 plans can seem like a daunting task. Luckily, there are a few standouts.

Determining which 529 plan is best means you need to examine a few points. For example, lower fees, a higher number of investment options, strong oversight at the state level, and a good approach to asset allocation all play a role.

While all of the 529 plans are worth exploring, here are a few that seem to be the best state 529 plans:

However, it is still wise to review all of the available options. Some plans offer additional benefits to residents, which may make a difference for you and your student. Plus, this allows you to determine if your student is eligible for any particular option and if the alternatives may be the best 529 plan based on your family’s needs.

What are the best types of 529 plans

College 529 Education Savings Plans by State

College 529 Prepaid Tuition Plans by State

While choosing the best 529 college savings plan for your student’s education does take some time and diligence, it is worth the effort. That way, you can select the program that will meet your family’s needs and provide you with the options and benefits you would like to have available.

Scholarships are a great way to make any college more affordable. If you and your student want to learn about how to find and land scholarships, sign up for our free college scholarship webinar! Take a quick trip over to http://thescholarshipsystem.com/freewebinar to reserve a spot today.

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