How a 529 Plan Works: Saving for College Tax-Free

What is a 529 plan?

A 529 plan is an investment account for education. You put in money you've already paid tax on, it grows without being taxed, and it comes out tax-free when it's spent on qualified education expenses: college, trade school, apprenticeships, and some K-12 costs. Use it for anything else and the earnings are taxed, plus a 10% penalty. Since 2024, some leftover money can also be rolled into a Roth IRA.

I have a 529 for my daughter. Mostly, I want her to be able to go to college without going into debt.

That goal comes from my own story. In high school I had a scholarship through a program my school offered and recommended, and I didn't take out any loans for my associate degree. I didn't realize how much that helped until about five years after college, when I saw how many people were in debt, and how big their loans were.

How does a 529 save you tax?

The name comes from Section 529 of the tax code, and the plans are run mostly by states. The tax break works like this:

1. Going in: no federal deduction. You put in money you've already paid tax on.
2. While it grows: investment gains aren't taxed.
3. Coming out: withdrawals for qualified education expenses are free of federal tax, and usually state tax too.

So the big win is the growth: every dollar of earnings can come out tax-free.

Many states add a deduction going in. My state's plan gives me a state tax deduction for what I put in. Not every state has one, and the rules vary: some only count their own state's plan, and some cap the deduction. Check what yours offers before you choose. The College Savings Plans Network (opens in a new tab) links to most states' plans.

What counts as a qualified expense?

According to IRS Publication 970 (opens in a new tab), qualified expenses include:

• College and other eligible schools: tuition, fees, books, supplies, and required equipment, at most accredited colleges, universities, and vocational schools.
• Room and board, if the student is enrolled at least half-time: up to the school's room-and-board allowance, or its actual charge for on-campus housing if that's higher.
• A computer, software, and internet access used mainly by the student while they're enrolled.
• Registered apprenticeships and recognized credential programs: their required fees, books, and equipment.
• Student loans: up to $10,000 over the student's lifetime.
• K-12 school: tuition and some other costs, like books and tutoring, up to $20,000 per student a year starting in 2026 (it was $10,000 before, under a 2025 change to the law (opens in a new tab)).

What if your child doesn't use it all?

Plans change, and that's fine. You have a few options:

• Change the beneficiary. Switch the account to another family member (a sibling, a cousin, even yourself) with no tax. Publication 970 lists who counts as family (opens in a new tab).
• Scholarships help, not hurt. If your child gets a tax-free scholarship, you can withdraw up to that amount without the 10% penalty. You'd still owe income tax on the earnings.
• Take the money out. Your own contributions come back tax-free. Only the earnings are taxed as income, plus the 10% penalty.
• Roll some into a Roth IRA, below.

Can a 529 roll into a Roth IRA?

Yes, since 2024. This is part of why I picked a 529: if my daughter doesn't use it all, part of it can go toward her retirement instead. The rules, from IRS Publication 590-A (opens in a new tab) and the SEC's guide to 529 plans (opens in a new tab):

• The Roth IRA is the beneficiary's, not yours, and the money moves directly from the plan to the IRA.
• The 529 has to have been open more than 15 years.
• Money put in during the last 5 years can't be rolled over, nor its earnings.
• Each year's rollover counts toward the yearly Roth IRA limit, along with anything else the beneficiary puts in an IRA that year. Like any IRA contribution, the beneficiary also needs earned income. (The IRA post explains the limit, and the IRS lists the current amount (opens in a new tab).)
• There's a $35,000 lifetime cap per beneficiary.

Moving the full amount takes several years, and the 15-year clock is one more reason to open an account early.

How much should you save?

Here's how I sized mine. I looked up the average in-state tuition, assumed 7% yearly growth, and worked backwards to a monthly amount. The National Center for Education Statistics (opens in a new tab) publishes average college costs if you want a starting point.

Here's a round-number example. Put $200 a month into a 529 from the day your child is born until they turn 18. At a 7% yearly return (an example, not a promise), it grows to $81,597.68. You'd have put in $43,200; the other $38,397.68 is growth, and none of it is taxed if it's spent on qualified expenses.

To work backwards, change the monthly amount until the ending balance lands near your goal. If that feels big, start with what you can: compound interest rewards starting early more than starting big.

How do you invest a 529?

A 529 is just the account: you choose investments from the plan's menu. Most plans offer age-based portfolios, which get more conservative as your child nears college, much like target-date funds, plus stock and bond funds. You can only change how existing money is invested twice a year, so pick something you can leave alone.

Mine is a mix: some high-growth options, some age-based, and some bonds. That's my choice, not a recommendation. For most people, I think a simple "set and forget" option, like an age-based portfolio, beats trying to time things.

Who can put money in?

Anyone can open a 529 and name a beneficiary: a child, a grandchild, a friend, even yourself. I'm the only one who puts money into mine, but family can contribute too, either once (a birthday or holiday gift) or on a regular schedule.

A 529 can affect need-based financial aid (opens in a new tab), and schools treat it differently, but savings still mean less to borrow.

Why it matters

My daughter knows about her 529. We've talked about it, more as one conversation than an ongoing topic. I don't think money should be taboo: talking about it is how we learn. I want her to understand spending, saving, investing, and giving, and a 529 is a real example of saving for something years away.

If college is on your list, a 529 gives its growth a tax break, and it isn't wasted if plans change. Just keep retirement on the list too.

This is educational, not financial or tax advice. For a decision this personal, consider talking with a tax professional or financial planner.

What to take with you

• A 529 grows tax-free, and withdrawals are tax-free for qualified education expenses.
• Check your state's plan for a state tax deduction. Not every state has one.
• Start early. Time does most of the work, and the Roth IRA rollover needs an account open more than 15 years.
• Work backwards from a goal to a monthly amount, then automate it.
• Keep it simple: an age-based portfolio is a solid "set and forget" choice for many people.

Want to try your own numbers? Use the compound interest calculator.