529 Plans Explained: How They Work and How to Open One

by Jalen & Sarah Bromley

In any discussion about saving money for college efficiently, the term “529 plan” is sure to crop up. It’s one of the most commonly cited ways to put away some dollars for your education — and there are around 16.14 million 529 accounts active in the US. Still, getting your head around 529 plans and whether they’re right for you can be confusing and a bit intimidating, as would be learning about most financial tools named after numbers, but don’t worry!

This guide will cover everything, from the basics of how 529 plans work to some warnings about what you need to know before opening an account.

What is a 529 plan?

529 plans are savings accounts for putting aside money for further education. They’re different from other savings accounts due to their tax-efficient status. When you put money into a 529 plan, you won’t have to pay taxes on your withdrawals — no matter how much growth your money enjoys. 

Originally, 529 plans were exclusively for post-secondary education, which is still their most popular purpose. However, in some cases, it’s now possible to use savings in a 529 plan for a wider range of purposes, including a Roth IRA and student loans payments — without losing tax benefits.

Types of 529 plans 

What you can use a 529 plan for depends on which type of plan you open: A prepaid tuition plan or an education savings plan.

Education savings plans

An education savings plan is the most common type of 529 account. In this case, you deposit after-tax dollars into your account and benefit from tax-free growth (which will fund your education later). The money you invest can be used for a variety of educational expenses, such as:

  • Textbooks
  • Accommodation
  • Tuition fees
  • K-12 education 
  • Meal plans
  • Apprenticeships

There’s also a lot of flexibility regarding which educational institutions you can use the money toward (unlike prepaid tuition plans)

Prepaid tuition plans

As the name suggests, a prepaid tuition plan involves paying your tuition in advance. This is a less flexible plan since you must use the funds to pay for tuition fees at a small number of eligible institutions. You must also select a specific college from the get-go. While you may be able to transfer credits from one school to another, this isn’t always possible.  

The money can’t be used for the same range of qualified expenses as education savings plans — only for tuition fees. Another disadvantage is that they’re not available in all states.

However, by paying the tuition fees in advance, you secure a lower rate than you’d be able to get elsewhere. So, if you know for sure you want to go to a certain college, this is probably the cheapest way to do it.

Pros and cons of 529 plans

Just because you want to save for education, it doesn’t mean that a 529 plan is the only option. If you’re unsure whether it’s the right choice, here are some pros and cons to consider.


Considering the average cost of a four-year undergraduate degree is now $10,940 for in-state students, most people need all the help they can get to save enough money for college. A 529 plan is one of the best ways to do this, thanks to their tax advantages.

Although you’ll contribute after-tax dollars to a 529 plan, once the money is in the account, you can withdraw it without being subject to tax — no matter how much the money grows. The more you add to the account, the more you’ll benefit. 

Let’s say a parent opens an account for their child and contributes $1000 a year until they turn 18. Assuming the historical growth rate of the S&P 500 is 10%, the total savings would have a final value of $50,159 after 18 years — that’s $18,000 of deposits and more than $30,000 of growth. There are some significant tax savings there!

In addition to the standard tax-free growth, some states offer extra incentives. For example, in Colorado, there are tax deductions on contributions to 529 plans. Other states offer tax credits. 


However, 529 plans aren’t for everyone due to their inflexibility. This is especially true of prepaid tuition plans, which are particularly restrictive. Even in the case of 529 savings plans, if you don’t want to pursue further education or an apprenticeship program, the 15-year wait to transfer the money to a Roth IRA will be your only option to enjoy the tax benefits.

Those in two minds about college may prefer to opt for other financial products, such as high-yield savings accounts or standard (taxable) brokerage accounts. You may not get the tax benefits, but at least the money will be yours to use as you like without worrying about withdrawal penalties. More on these penalties later.

There are also some restrictions to be aware of. If you have an in-state 529 plan, you may need to use your savings toward education pursued in the state you reside in. And even within the same state, not every institution is compatible with every plan.

How to open a 529 plan and make contributions

Now we’ve demystified how 529 plans work, let’s look at how you can actually open one. Make sure you avoid some common mistakes and misunderstandings along the way.

1. Choose plan type

Your decision over whether to open a prepaid account or a savings plan will affect the type of account you can open, so this is your first decision.

2. Open account

To open a 529 account, you’ll need to choose a provider. This can be a somewhat tricky process since state-specific and countrywide options are available. If you choose a state-specific plan, read the requirements carefully to see if they limit you to attending a college within that state.

Regardless of which type you choose, you should pay attention to other rules, such as fees and maximum contributions.

You can find a list of providers on the College Savings Plans Network site, which lets you filter by criteria to help you narrow down your options.

3. Select beneficiary 

The beneficiary of a 529 plan is the person using the funds toward their education. This doesn’t have to be the account owner—in fact, in most cases, the beneficiary is the account owner’s child or grandchild. However, the account owner and beneficiary don’t necessarily have to be relatives.

Someone can be named as the beneficiary of multiple 529 plans (if they’re lucky enough to have various wealthy relatives), and it’s possible to change the beneficiary at any point.

The eligibility requirements are fairly simple:

  • The account owner must be 18 years old (beneficiary can be under 18)
  • Residency requirements vary between states 
  • Must use money for qualified expenses at eligible institutions

4. Fill out the application form

Once you’ve decided on these details, you can finish the account opening process by filling out an application form. This is generally done online. Expect to provide the following for both the beneficiary and the account owner:

  • Social security number
  • Date of birth
  • Address

In some cases, you may need to make a deposit immediately to open the account.

5. Make contributions 

If you’re opting for a savings plan, your 529 account is essentially an investment account. There are two primary choices: to open an account through a broker or to go DIY. 

Opting for a DIY approach is more cost-effective since it doesn’t involve fees. It may seem daunting if you haven’t invested before, but you can choose a passively managed fund instead. This contains a “basket” of investments that will diversify your portfolio.

Some also have a target date, which means that the risk profile for the fund will gradually decrease as the date the beneficiary will go to college approaches.

At this point, you’ll also have to figure out exactly how much you’ll contribute to your account. If you have a lot of money to spend, you may not necessarily want to put everything into your 529 plan.

If you’re unsure exactly how much you need, you can use a college savings calculator such as this one from BlackRock.

6. Beneficiary requests withdrawal

When it’s finally time to use the money, the beneficiary needs to request a withdrawal. You can do this by filling out a withdrawal request form or by calling the plan provider. You’ll need to confirm that you’re using the money toward qualifying expenses.

When to open a 529 plan

Since 529 plans are all about tax-free investment growth gains, the earlier you can start one, the better. Parents and grandparents often save on behalf of their children early in their childhoods.

However, you can still benefit if you get into the game late. There are no restrictions on age, and you can keep your money in the plan indefinitely. One or two years of tax-efficient growth is better than none at all!

Plus, you may be able to use the funds toward a graduate program—or even pass the plan on to a different beneficiary.

Important considerations 

If everything sounds good so far, there are still a few details to keep in mind before you go ahead and open a 529 plan.

Financial aid

In most cases, a 529 plan won’t affect a student’s eligibility for financial aid since it carries less weight than the expected family contribution (aka the financial circumstances of a student’s family). However, it can still have some impact.

Assets owned by parents — including 529 plans — decrease the amount of aid a student can receive by up to 5.64% of their value. This is a shame, but some other types of assets reduce financial aid eligibility even more, so it isn’t a reason to shun the idea of a 529 plan.


Early withdrawals from 529 plans for non-qualified expenses are subject to a withdrawal penalty of 10%, plus taxes. This isn’t necessarily a major issue for those who simply had some money left over in their account after graduating, as they can use it toward their student loans instead without facing a penalty.

But for anyone who changes their mind about education altogether, it’s a problem. Although there are some ways to get around this — such as transferring the funds to a different beneficiary — this won’t be ideal for many.

IRS rules

While you can transfer up to $35,000 of a 529 plan into a Roth IRA, this only applies to accounts that have been open for at least 15 years, and any contributions made in the last five years aren’t eligible. 

You should also keep in mind that you can only change your mix of investments twice per year in a 529 savings plan due to IRS rules.

Get college-ready

529 plans are one of the most effective ways to put aside funds for college, largely thanks to their tax benefits. However, they come with their fair share of quirks and complexities — you’ll need to decide what kind of plan to open, check its requirements, and decide what funds to invest in. It’s a lot of work, but any debt-saddled college graduate would surely tell you, it’s worth the investment.

Raising the funds for your college expenses is just the start of a student’s financial journey. At Frugal Student, we share everything else savvy college students should know, from budgeting tips to dealing with student loans.

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