How We Use 529 Plans To Save For College

We are SO EXCITED about our 529s!!!!

December, with all its merry festivity, is naturally the month we contribute to our daughters’ college funds. Ah yes, just what every four-year-old and 22-month-old want for Christmas: well-funded 529 savings plans.

Don’t worry, in addition to putting $5k into each of their 529s, we did give them actual Christmas gifts (most of which were either hand-me-downs or purchased at garage sales last summer… ).  

Save On What Doesn’t Matter: Spend On What Does

This is my approach to spending money on our kids. So, yes, they both have hand-me-down cribs and a dresser we found on the side of the road, and used clothes, and toys from yard sales. And yes, they have snow pants from thrift stores and coats that don’t match; but to me, none of that matters.

Buying used stuff for your kids isn’t going to save enough money to put them through college, but it will save something and something is better than nothing.

Focusing on longterm goals–for yourself, for your kids–is an excellent way to avoid meaningless short-term spending.

Here are a few posts on how we save money during the early years of parenting:

What’s a 529 Plan?

What every child hopes for on Christmas morning: a 529 plan in a bag

Try to contain your excitement. I’ve received A LOT of questions about 529 plans over the years, so to the people who’ve asked those questions: your time is now. 529s are college savings plans.

There’s a lot of confusion about 529s and for good reason: they are administered by the states and they vary from state to state.

Adding to the confusion is the fact that you don’t have to use the 529 offered by your state. Many people do use the 529 offered by their state because a lot of states provide a tax benefit for in-state contributors. In other words, in some states there’s a state tax advantage if you contribute to your state’s 529.

Furthermore, some states have residency requirements regarding their 529 plan, so you’ll have to check into your state’s rules. NerdWallet has this nifty overview of what each state does (and does not) offer when it comes to 529s.

If you have kids and if you think they might go to college and if you have some money to put towards saving for their higher education, a 529 plan might make sense for you. I rarely discuss 529s (or advise people to use them) because it really, really, really (we’re talking really) depends on your personal tax circumstances, the state you live in, and your future/projected/potential plans for your kiddos.

A few advantages of 529s:

  • The state tax advantage (in some states). Note that your kid doesn’t have to go to a college in your state, unless you’re looking into a pre-paid 529 plan (which means you lock in today’s tuition rates at a specified state school).
  • Other family members (or friends!) can make contributions to your kid’s 529, which is an easy way for them to help you save for college over the years.
  • Arguably the most significant advantage is that the money in a 529 grows tax-free and isn’t subject to federal income taxes when it’s withdrawn for educational expenses. This is what makes a 529 a better college savings vehicle than, say, a regular taxable brokerage account.

Some downsides of 529s:

  • Depending on your state–and your state tax burden–a 529 might not be all that advantageous from a state tax perspective.
  • The money is restricted for use on higher education and related items (room, board, tuition, computers, etc).
  • You can withdraw the funds for other purposes, but you’ll pay a fine (see below).

What if my kid doesn’t end up going to college? Or gets scholarship?

I did not realize that Littlewoods’ (hand-me-down) romper matched the (hand-me-down) tree skirt exactly…

You have a few options in these scenarios:

  1. You can withdraw money for something other than educational expenses; however, the withdrawal, “will be subject to state and federal income taxes and an additional 10% federal tax penalty on earnings” (source: SEC).
  2. You can change the beneficiary of the account. So if one of your children isn’t going to use their 529, you can transfer their 529 to another of your children.
  3. If a kid receives a scholarship, you’re allowed to withdraw the amount of the scholarship from their 529 without penalty (although you will have to pay taxes on any gains in the account). Alternately, you could keep the money in their 529 as it can be used later for graduate school.

When should I open a 529 for my kid?

Ideally as early as possible. Since 529s are invested in the stock market, they need time to grow. The longer they’re invested, the more likely they are to grow. If you start a 529 when your child is born, you’ll have 18 years of growth in their account.

This is one argument for starting a 529 when a baby is born, even if you can’t contribute very much money at the outset. In some states, there’s no minimum contribution amount and in other states, it’s as low as $10. And if you’re looking for a baby shower gift that’ll keep on giving–a contribution to a 529 account is a fabulous way to go!

Fun fact: they’re called 529s because they’re  governed by Section 529 of the Internal Revenue Code. If that’s not cocktail party fodder, I don’t know what is.

Put Your Own Oxygen Mask On First

While saving for your kids’ college education is a nice thing to do, it shouldn’t come at the expense of your retirement savings. Your kid can take out loans for college; you cannot take out loans for retirement. A 529–or any other college savings account–should come second to retirement savings. Think of it this way: it’ll be better for your kids to take out student loans than to be financially responsible for you in your old age. Put your own oxygen mask on first, fund your retirement accounts, and then look into saving for college.

A Few Good Resources on 529s:

This has been your hopefully helpful, hopefully not-too-confusing, not terribly boring primer on 529 college savings plans.

Do you have 529 accounts for your kids?

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62 Responses

  1. Nice post! One comment: you said, “This is what makes a 529 a better college savings vehicle than, say, regular old index funds.” I think you meant to say a 529 is a better vehicle than a taxable brokerage account. Our college savings are invested in index funds, just within the tax shelter of a 529 plan.

  2. Liz says:

    You can now use up to $10,000 to pay for private school not just college expenses.

    • Carla says:

      It depends on the state. That is correct on a federal level, but not every state has updated their statutes yes to comply with the Tax Cuts and Jobs Act. So it’s a good idea to double check with your state 529 plan to be positive that type of withdrawal is allowed and will not be subject to a penalty.

    • Cameron Morgan says:

      Not in every state (Colorado, for instance).

  3. Vicky says:

    I have set up 529 plans for each of my 5 grandchildren. I started them at their births. I contribute monthly. I don’t believe in giving them meaningless junk for bds, holidays etc. I do give them books/puzzles/$ for those. They may think I am cheap now but hopefully will appreciate it later. Also, if one chooses not to go to college, I can switch that $ to another grandchild. Those monthly amounts add up over 20 years.

    • Katie says:

      My grandparents did the same for me, and I’m at least anecdotal evidence that they will appreciate it. I barely noticed it growing up, and am so thankful as an adult. I only took out one, small student loan (my dad though it’d be good for my credit score) and I paid it off by 25.

    • Meg says:

      Vicky, I am 100% with you on starting them for grandchildren early. We started them for each of our 3 grandchildren as soon as they had ssn’s and it is so nice to see the balance grow.

    • Katie Camel says:

      That’s a fantastic gift for your grandchildren. They may not realize now, but they’ll be incredibly appreciative when they’re older. I know I was! Yes, those monthly amounts certainly add up over time.

  4. Charlotte says:

    When my first child went to state university, we discovered that loans don’t cover the full amount. University, different than community college, ASSUMES parents take on 50% obligation. So, student loans for university education will only give a loan for 50% to the student and a loan for 50% to the parent. Community college gives greater than 100% loan to the student, because those students are not assumed to be supported by their parents.

  5. Claire says:

    Some states also do matching contributions for low and moderate income families. Our family is in the tax bracket where we contribute $25/account and the state matches it with $500. Even though we’re not able to make large contributions, we’re able to afford the small contribution required each year to get the state match.

  6. NerdPit says:

    One other consideration, similar to employer 401K plans, is that sometimes there are matching funds available that are basically free money. I work quite a bit with Maine’s 529 plan and they have several different grant programs that aren’t mentioned by that NerdWallet link. I’m not sure how common this is across other states though. Some of the grants require a Maine beneficiary while the others require either the beneficiary or a account owner to live in Maine so these aren’t an option for fully out-of-state savers.

    • Mrs. Frugalwoods says:

      Thank you for sharing! That’s a great resource! I think you’ve also highlighted why 529s can be so confusing: they vary so much state to state.

    • Jamie says:

      We’re Maine residents and take advantage of the Maine 529. Maine offers a $500 grant to every baby born in Maine (if claimed within the first year), which can be used as the seed funding for the 529. Maine also matches 50% of each contribution up to $300 in matching funds per year. The proceeds can be used at any college, not just state schools. Separate and apart from the 529, Maine has student loan tax credits that vary depending on whether you attended a Maine-based college/university.

  7. Christina says:

    Timely post! We are feverishly putting money away in 529s because our window is closing and we didn’t save enough when our kids were young. They are now 11 and 14 and if I could go back in time and at least trickle money in, I would. Two quick things – it’s important to use a direct plan. Some 529s require you to use a broker/advisor to get in, which costs money. We made that mistake initially when our financial “advisor” at the time initially enrolled us in a 529 through Virginia several years ago. We have since switched to a direct 529 in New York where the fees are super low. There are plenty of direct 529 plans out there and they are pretty easy to navigate on your own with age-based investments, etc. So, don’t make our mistake! Also, while I totally understand the importance of retirement savings, I see retirement vs college savings as an “and” conversation rather than an “or” one. I think people really do need to do both. The cost of college is insane and has outpaced inflation several times over, and thus the student loan crisis. (BTW – Vanguard has a great college savings calculator that lets you see how much you need to save to pay for college in the future.) From a psychological perspective we personally had to prioritize both (and reprioritize our other spending), otherwise we kept putting college savings on the back burner in the name of retirement. Just trying to save enough to pay for in-state tuition (that continues to rise) is a colossal task. Just my two cents! 🙂

  8. Michele Y says:

    I set up UTMA accounts through my bank when each of our girls were born (got SS cards in the mail during maternity leave and off to the bank we went!). Thought I was doing a good thing at the time, but now I’ve come to realize that (1) we need 529 plans STAT, but (2) converting their UTMAs to 529s means I don’t get to keep the beneficiary-changing benefit of a typical 529 (because the UTMA savings account is ultimately a trust, and each child is the beneficiary of that trust, so those funds may only ever be used for that child’s benefit). We now have thousands of $$$ saved for each child there….if this were your situation would you flip these UTMAs to 529s for each child (and start with a good chunk of change for investing), or leave them as is and just open new 529s for each (even though that means starting investing with way less $$$)? Wish I’d had a better understanding of what I was setting up back when I originally opened the UTMA accounts….and realized back then that starting a 529 was a possibility! #hindsightisalways2020

    • Michele Y says:

      to add a little more detail to our specific situation….our oldest will turn 7 in May, and our youngest turns 4 tomorrow! So we still have some time to save….I just hate to start from scratch, but am concerned about the risk of the UTMA converted to 529 (i.e. if someone decides not to pursue higher ed, all that $ being taxed and penalized….whereas a fresh 529 start means I could just change the beneficiary to the other kid, my nieces or myself even if college/education isn’t the future plan for one of my daughters). it’s hard to think neither of them will end up in college in today’s climate…….but #2…she’s a bit of a wild child already and likes to throw curveballs. hahaha!

      • Matt L says:

        Michelle, those are really specific questions with large potential consequences, you should really seek out a qualified tax advisor for those answers.

  9. Shannon says:

    Did you buy them through the state of Vermont?

  10. Anastasia says:

    Our kids grandad kindly put money in a 529, but the investments performed kind of badly relative to index funds. We are hoping this will even out over time. Everyone should take a close look at investment options within the 529 plans, fees, and performance, and understand what you’re getting into. On the positive side, I have heard that if you don’t use all the 529 funds for your kids college, you can use it for your own continuous education in some States. True?

    • Linsey says:

      Yes, true you can designate yourself as new beneficiary if using for qualified education expense.

      Source from section 529:
      Any change in the designated beneficiary of an interest in a qualified tuition program shall not be treated as a distribution for purposes of subparagraph (A) if the new beneficiary is a member of the family of the old beneficiary.

  11. Liz says:

    As of 2020, $10,000 from a 529 can also be used to pay the beneficiary’s student loans, which I just read in NYTimes. I will be opening one in my name this year while I finish paying those down. Thanks for the article! My husband and I just opened a 529 for our 4-year-old son.

  12. Allie says:

    One comment from a non-parent. I love contributing to 529s over lavish gifts for small children. Even if parents aren’t able to contribute much when a child is very young and cash-flow is low, it is worth the effort to set up a 529 that allows gifts from family/friends. Every little bit helps!

  13. Lauren Elizabeth Westmoreland says:

    Another thing to note – you can now use up to $10k per beneficiary to pay back student loans. If your child has access to any direct subsidized student loans, this could be a way to let some of the 529 money make extra $$$ for the years your child is enrolled.

    We have (2) 529 accounts for each of our three kids – one in the state that we live (GA – so we can get the tax deduction) and one in a state that had the lowest fees at the time (NY). In these early years, we want to contribute more than the tax deduction amount so it can sit there and grow; hence the two accounts. Make sure to look at the fees! https://www.savingforcollege.com/529_fee_study/lowest.php

    To be real: I am just repeating information and have no actual knowledge on NY’s actual fees or if it’s still the best bet – it was all my brilliant husband who did the research and selected the plans. He said he’d take care of it and I mostly turned my brain off on this subject, other than to gleefully watch the balance grow in Personal Capital.

  14. Danielle says:

    I setup a 529 account shortly after my son was born, because my state offers a tax benefit for investing in one. I haven’t been able to put in as much as I’d hoped, but I did contribute $2k to get the full tax benefit for the year. I also contributed the cash he was given for Christmas from his grandparents, and plan to do the same for any other cash gifts he might receive, at least until he cares what happens with his money!

  15. Evan says:

    I just had one comment on tax-advantaged accounts. Unless you have an upper-middle-class income, 529s may not be useful. The capital gains rate for the majority of households is 0%. So unless you need to shelter money, or you want to protect dividends from bonds, a 529 is not going to help much. Like Ms. Frugalwoods said, it all really depends on your personal situation.

  16. Bobbi says:

    We started our son’s 529 when he was less than a year old and it has been the best investment ever. Between the state tax benefits (we’re in VT), coupled with the gain (48% of the balance is gain), it’s a great feeling to be able to support him in this way. Sure he might still have to take out student loans, but this will surely cover much of the expense (he’ll be off to college in the Fall). We started with small, automatic monthly contributions, and increased the contributions over the years as our budget allowed.

  17. Cindy says:

    Some states will allow you to apply for a state-funded contribution to the account if you meet a minimum contribution in the first year. Be sure to look into that!

  18. Carla H Morris-Robinson says:

    I started 529s for both of my children when they were toddlers. As they approached the preteen years both have shown a record of very good grades and an interest in joining the National Gaurd. Because these two things could lead to scholarships and/or help from the GI Bill, I have started putting the amount we were contributing to their 529s into my Roth (in addition to our regular contributions for retirement, we are on track for our financial goals and had room under the maximum limits). Under the Roth rules, if my kids do need help from us, we can pull out the principal without penalty, but if they don’t need much financial help from us, we have more for retirement or can gift them the money for a down payment on a home. Also, the money in the Roth doesn’t count against them for potential financial aid. This is based on my research and I could be wrong, please let me know if I am. So good to be having this discussion about helping our kids avoid high student loans!!

    • Alex says:

      We concluded that in our state (Hawaii) there is no real advantage to a 529 over a Roth, so although we do have a New York 529 (we liked their funds best), we mainly put the kids’ college savings in our Roth because of the greater flexibility. If this is a bad assumption, and anybody feels like correcting me, I’d love to hear why.

  19. caryatis says:

    >Other family members (or friends!) can make contributions to your kid’s 529, which is an easy way for them to help you save for college over the years.

    You can also set up your own 529 for someone else’s kid. That way you can control the investments and whether the money gets withdrawn. Also a good way to hedge your bets if (say) you might have a kid but you might not–if the account is in your name, you can change the beneficiary.

  20. Carrie says:

    Here is a good article about why 529s might not be a good fit, depending on your family: https://www.gocurrycracker.com/why-gccjr-has-no-529/

    • Evan says:

      Exactly. We have saved enough for my kids to take community college courses while they’re in high school; but otherwise, there’s no incentive for me to save any more in a 529.

  21. Martha C says:

    We used 529 plans for all three children (now all college grads!! hooray!) and I highly recommend them. We did make a large mistake, which was not converting soon enough to cash. Our oldest graduated HS in 2010, and we should have converted to cash by 2007 or so, but instead we tried to catch the upside of a booming stock market and instead felt the effects of the crash. So she did not end up with as much as our younger two kids, because their accounts had more time to recover.

  22. Brian says:

    And as your 529 account(s) grow with your kid(s), pay attention to the fees that your plan charges. Those fees don’t mean too much when the account balance is small but add up as it grows. You can transfer the balance to another, lower cost 529 plan, and keep contributing to your state plan to continue receiving the state tax benefit (can only transfer once per year though).

  23. JD says:

    We used Florida Pre-paid tuition for both of our kids. When one graduated with an “hour” or so unused, we transferred it to our at-the-time only grandkid’s plan account. Paying ahead was the only way we were going to be able to pay for their college; it locked in the tuition rate for them at the time we bought the plans (when they were 3 and 1). Both of our kids graduated debt free, so they immediately set up Pre-paid plans when they had their own kids.

  24. Pauline says:

    I don’t have kids so I just put myself through college   My sis has 7 kids – 1 took out college loans, 1 put herself through with 100% scholarships, teaching fellowship to get graduate degree, 1 had 50-85% scholarship and worked to pay the rest so no debt. One kid had no interest in going to college, another one started college after having 4 kids and joining the army she is getting her tuiton paid by the army. 2 kids still in high school so they are looking for ways to go to college like athletic & academic scholarships.

  25. Allison says:

    A few personal questions if you don’t mind: 1) Do you plan to put $5k annually or just a one-time contribution that you hope will grow?, 2) What is the number you are hoping to have saved for your kids college fund?, 3) Any suggestions on encouraging family members to contribute instead of Christmas and birthday gifts? My daughter is 13 and asked for 529 contributions this Christmas but none of her aunts or uncles contributed but instead sent things she could use or didn’t want/need. She is already hoping to do a study abroad while in college and is trying to plan ahead. We travel a lot and she is seriously considering college in Norway, where we have distant relatives.

  26. Kimberly says:

    My husband and I have 529 plans set up for our two sons, ages 9 and 14. We’re very behind on college saving, though, and are just starting to contribute in earnest. Where we live there is a tax deduction of $3340/year per beneficiary. Is it possible for my husband and me to set up 520 plans for ourselves as well, in order to take four total tax deductions of $3340/year, and then transfer that money to our kids when the time comes?

  27. Kimberly says:

    (Obviously I meant set up 529 plans, not 520 plans! Oof.)

  28. Erica says:

    Mrs FW, thanks for this update and all your wonderful content! Curious if you could explain the change of heart from this 2017 post where 529s didn’t seem like a good option for your family at the time?
    https://www.frugalwoods.com/2017/01/24/our-low-cost-no-fuss-diy-money-management-system/

  29. Hannah says:

    My state (Colorado) has a matching grant program. It’s awesome, up to a $500 match for each year you qualify (I think for 5 years total per child). So we are definitely taking advantage of that while we can. A great benefit of being frugal is being able to be a single income family while I stay home and still save 😉 I don’t know how many states offer a similar program though?

  30. BookAunt says:

    In regards to asking for 529 plan contributions as gifts, instead of just asking generally for contributions , ask for enough money to fund an hour of tuition at a specific college (or a class). Or for a textbook (look online for prices of different types of textbooks). For Christmas I gift my grandchildren the value of 1 hour’s worth of tuition at the local community college into their 529 plans.

  31. Ashley says:

    I only have one child and I have just been putting money into a higher interest savings account which isn’t going to grow as much as a 529. I feel safer not contributing to one but would still like to save in case my child wants to go to school i will have something to put towards it. Where would you suggest I save this money for “college” that won’t be taxed if it is used for something else instead?

  32. Ashley says:

    If 529s are transferrable to family members, would it make sense to just have one 529 plan for multiple children? This way there is the advantage of the interest being applied to a larger sum and would grow at a faster rate. Is there a benefit to having a 529 for each child?

    • Leah says:

      I have this exact same question! : ) We have two children, who are three years apart. We set up a 529 for the first child but have not yet set one up for the second child (he’s only 2 months old).

    • Betsy says:

      There is a paperwork to transfer between children, so you want each child to have their own account.

  33. Matt says:

    We set up a 529 plan for my kid as soon as we got a positive pregnancy test. You can start one whenever you’d like in your name and then transfer later, so if you’re planning on having kids some day, no reason to wait. We used Fidelity, which is also the manager of the fund for our state (MA). They have a dedicated gifting page for each account that you can share the weblink with friends and family. We had the link printed on our baby shower invitations, it gets printed on Christmas cards, and will go on future birthday party invitations. One MAJOR consideration is your kid’s potential student aid impact. If the 529 plan is held in their name, the parents name, or someone else’s name (grandparent) can have a major impact in determining their financial aid. Use the Google to learn more. Also this info is good for today, who knows what changes will be made in the next 15-18 years, but if I had to guess, I’d say that the rules will be very similar if not exactly the same. Here’s a good link to the in’s and out’s of the financial aid impacts of the 529 plans: https://www.savingforcollege.com/article/yes-your-529-plan-will-affect-financial-aid

  34. Cat says:

    When our youngest daughter decided to go to school in the UK we were concerned that we wouldn’t be able to use her 529 but we’re pleased to find out that we were able to use it even for overseas education.

  35. Natasha says:

    Our oldest daughter ended up with a full
    College scholarship- book voucher and all so we were able to use her 529 savings for a month in Spain. Our 529 plan doesn’t reimburse for international education but the credits were granted by a local university (Tulane) so we wound up being reimbursed for the month in Spain due to that. win, win! The remainder of her 529 plan can be transferred to our two younger children.

  36. LongTime Frugal says:

    We took advantage of our state selling “college bonds”, aka zero coupon bonds. Wish we could have purchased more but between those, scholarships (less available for younger kid as the economy tanked for the 3rd but not last time during our married years), and general savings, no debt for either kid or us. Lowest interest rate on the bonds was 6.1%, highest 8.4%, guaranteed. But as most have said, the earlier you start saving, the better. Just watch the fees and fund/fund management. In some states, the criteria for choosing the choice of funds was not without political influence.

  37. Betsy says:

    We love our 529 plans…esp. during this boom economy! The gains are more than the initial investments, by a lot! A agree with a commenter that you need to take the money out early enough that you don’t have to worry about a downward turn in the market. Also we are planning to cash flow $4000 per kid per year in tuition so that we can take advantage of the American opportunity tax credit. (There are income restrictions on this though and you can’t double dip with the 529)

  38. Kris says:

    I started my 529s for both my boys right when they we’re born. I believe for our first one, who is 3 now, I opened one a few months before he was born. This is a great option for parents to keep money stashed away for their kids and like you said it will grow more in the stock market. Fortunately, the grandparents have put down a pretty amount for them on both of their accounts. We plan to put down a fixed contribution amount in the next few years but haven’t decided on what that amount will be. So far after putting down $1K on both accounts when it first opened it’s been random contributions from family like our parents and money gifts from Christmas and birthdays.

  39. Maddie says:

    Hi there! I have a question and maybe it’s too state specific to be answered here, but what happens if you open a 529 for your kids in one state and then later move to another state? Since you are no longer a resident of the state you opened the 529 in, are you supposed to open a new 529 in the new state and transfer the money, or can you leave it in the old state’s plan even though you are no longer a resident? Just curious…

  40. Mike says:

    Hi Mrs. FW – on a related matter of helping them save, not sure if you’ve covered it before, but do you pay your little models for appearing on your blog, enabling nice FI tricks like Roth IRAs for them, etc? I’m interested in doing that for my site but not sure of the going rates. Are you able to share any resources or even the rates you use? My daughter is of at least comparable cuteness 🙂

  41. Bob Burakiewicz says:

    If you will be looking for financial aid when they go to college the 529 plan will affect it. It is possible the penalty will be as high as 20% per year they are in college. You would be in a better position if the money was in your name. The penalty would be about 5.65%. This is just one of the unknown facts about financial aid. I do workshops on this subject and find many unintentional mistakes parents are making.

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