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Saving for College- 529 Plans

529 Plans are state sponsored plans that give individuals a tax advantaged way to save for college. There are two types of 529 plans: prepaid tuition plans and education savings plans. Prepaid tuition plans are pretty self explanatory and a topic i’ll cover in a future post. The education savings plan option allows a saver to grow an account tax free and take distributions tax free so long as the distributions are used for qualified higher education expenses.

Unlike the Coverdell ESA plans I covered earlier, 529 plans have no income limitations on who can contribute and no annual limits on how much you can contribute (although some states cap the overall amount you can contribute at a very high number). Contributions are considered a gift so amounts in excess of your annual gift tax exclusion amount ($15K in 2021) will count against your lifetime gift and estate tax exemptions. 

What are qualified higher education expenses?

For college students, qualified higher education expenses include tuition; room and board; mandatory fees; and, books, computers, and software (if required). Education savings plans can also be used to pay up to $10K annually per beneficiary for tuition at any public, private or religious elementary or secondary school. 

Under recent law changes, up to $10K in student loans can be repaid using 529 plan funds. Apprenticeships are also now qualified expenses.

Investment Options

Each state chooses its own menu of investment options, generally a few ETFs or mutual funds including some target date options. You don’t have to choose the plan from your state of residence, although there are sometimes tax benefits to doing so.

In Washington State savers are given a selection of 7 different static portfolios based on risk tolerance. Those portfolios are made up of various Vanguard and Schwab stock and bond index funds. There are also year of enrollment portfolios that work just like target date retirement plans (getting more conservative as the beneficiary nears college age). 

One of the reasons I prefer Coverdell ESA plans to 529 plans is because of the limited investment options in 529 plans combined with their fees. In the static portfolios available under the Washington State plan, fees range from .25% to .33% per year for passive index portfolios. You could easily recreate those static portfolios in a Coverdell ESA while paying annual fees of .05% or less. 

State Tax Savings

Many states offer tax benefits for contributions to a 529 plan. This is not a benefit to residents in states with no income tax (such as Washington). 

For a state like Idaho, contributions to Idaho’s plan of up to $6K annually per individual ($12K per married couple filing jointly) are deductible from your Idaho taxable income. Oregon on the other hand got rid of their state income tax deduction for 529 contributions and switched to a credit instead. Oregon residents receive a credit of $150 per individual ($300 per married couple filing jointly). 

What happens if a beneficiary doesn’t go to college or withdrawals are made for non qualifying expenses?

Beneficiaries will pay income taxes on the earnings portion of distributions from a 529 plan if those distributions exceed qualified educational expenses.There is also a 10% federal penalty on those earnings withdrawn. Unused balances may be transferred without penalty to another family member. There is no age that a 529 plan must be distributed so the account could theoretically grow long after a beneficiary is past college age and then be transferred to someone else defined as a family member.  

FAFSA & Student Aid

529 balances are considered assets of the account owner (not the designated beneficiary). Thus if a parent is the owner of the ESA account, under current rules 5.64% of the account would be considered available funds to pay for college. If a grandparent or third party is the account owner then the assets would not be reportable for financial aid applications. However, distributions from a 529 plan not owned by the student or their parents used to pay for their college will be counted as untaxed income on the FAFSA. 


While I prefer the Coverdell ESAs to 529 plans, many parents will find they cannot save enough in an ESA. Thus I think the adding a 529 plan makes a great addition to a Coverdell ESA to help you save for college in a tax efficient manner. Make sure you do the research to find the best state plan for your needs. 

Scott Caufield, CFA, CPA