What is a 529 plan, and is it worth using?

A 529 plan is a state-sponsored investment account for education expenses. Contributions are made with after-tax dollars, investments grow tax-deferred, and withdrawals are entirely tax-free when used for qualified expenses, which include tuition, fees, books, required equipment, and room and board for students enrolled at least half time. Many states offer a state income tax deduction or credit for contributions, sometimes only for contributing to that state's own plan, which is worth checking since it can be the largest single benefit.

The scope has broadened considerably. Qualified expenses now include a limited annual amount for K-12 tuition, registered apprenticeship costs, and student loan repayment up to a lifetime cap per beneficiary. Beneficiaries can be changed to another qualifying family member, which handles the case where one child does not attend college. And under rules from the SECURE 2.0 Act, unused funds in an account open for at least fifteen years can be rolled into a Roth IRA for the beneficiary, subject to a lifetime limit and annual contribution limits, which substantially reduces the historic risk of overfunding.

Two cautions. Non-qualified withdrawals owe income tax plus a penalty on the earnings portion, though the penalty is waived in specific circumstances including scholarship receipt, disability, or attendance at a military academy. And financial aid treatment matters: a 529 owned by a parent is assessed at a low rate on the aid formula, while one owned by a grandparent was historically treated less favorably, a treatment that changed with recent FAFSA simplification, so verify the current rules rather than relying on older advice. Compare your own state's plan against low-cost out-of-state options, since plans vary widely in fees and investment quality and the state tax break does not always offset a bad menu.