Planning · July 14, 2022

How Do 529 Plans Work?

The exploding cost of higher education today should have every family with a potential student considering two tough questions.

  • When is the best time to start saving?
  • With college expenses increasing at over 8% per year, are your savings keeping pace?

In the 2021/2022 school year, the College Board estimates the average in-state cost of one year at a four-year public college is $22,690. The average cost for a year at a private four-year college is estimated to be $51,690. Many schools cost substantially more.

Even with student loans, financial grants, work-study programs and current income availability, families continue to depend on personal savings as their college-funding cornerstone. There are a few savings options available, including 529 plans, Coverdell Education Savings Accounts, custodial accounts and more. In this article, we're taking a deep dive into 529 plan structures and options to help you understand which may be best for your family.

A Tax-Advantaged Education Savings Option

Among the many available education savings options, 529 plans are one of the most popular vehicles for families and students. That's because they have federal tax benefits, including tax-deferred growth and tax-free withdrawals on qualified education expenses. Originally limited to post-secondary education costs, they were expanded to cover K-12 education in 2017 and apprenticeship programs in 2019.

Each state is responsible for administering its own 529 plans. As such, the fees, expenses and features of the plans vary by state, but as long as the plan satisfies the requirements of Section 529 of the Internal Revenue Code, federal tax law provides tax benefits for both the contributor and the beneficiary. These benefits include the following:

  • Contributions to a tax-advantaged 529 plan accumulate on a tax-deferred basis.
  • Withdrawals are tax-free at the federal level if the money is used for qualified educational expenses. Withdrawals not used for qualified expenses are subject to income tax and a 10% federal penalty.
  • There's no income limit to participate.
  • Lifetime contribution levels are $350,000 and up (limits vary by state).
  • In 2022, super-funding is possible up to $80,000 ($160,000 for joint gifts) with no gift-tax implications if requirements are met. The availability and features of 529 plans vary by state.
  • Thirty states also offer tax breaks on top of the federal tax advantages.

Making regular, methodical savings over time—combined with raises, tax refunds and unexpected financial windfalls—could supplement or possibly fully fund the cost of a child's education.

529 Savings Plans Versus Pre-paid Tuition Plans

529 plans have two main structures—a savings plan and a pre-paid tuition plan. This means, in addition to the tax-advantaged nature of 529 plans, families can also select the product that best fits their needs and risk tolerance.

The 529 savings plan is an individual investment account. Contributions are directed to the plan's investment portfolios and can be used to pay tuition, fees, room and board, books, and supplies at accredited institutions. Funds can also cover K-12 tuition expenses up to $10,000 per year.

The pre-paid tuition 529 plan allows the purchase of college tuition credits at today's prices to pay future costs at participating colleges—typically limited to in-state schools. There are two general types of pre-paid plans:

  • Contract plans commit the account owner to purchase a specified number of years of tuition in exchange for a lump sum or periodic payments. Contract plans offer lower prices for younger beneficiaries since the state or school has more time to invest the money.
  • Unit plans allow the account owner to purchase a fixed percentage of tuition. In a typical unit plan, one unit represents 1% of a year's tuition. All participants in the plan pay the same price per unit.

Other 529 Plan Benefits

The tax-advantaged nature of the 529 plan makes it appealing to many families. There are other benefits to consider, too:

  • The donor stays in control of the account.
  • Should the intended beneficiary not use the funds, the beneficiary can be changed to another family member.
  • Account maintenance is relatively hands-off.
  • 529 plans don't need to be included in your federal tax return.
  • Plans offer the flexibility to change your options twice a year.
  • Plans may be rolled over into an ABLE account.
  • Everyone is eligible—there are no income, age or contribution requirements, although some states have age restrictions for the pre-paid plans.
  • 529 plan funds can be used to pay for study-abroad expenses if the study program at the foreign institution is eligible for credit at the student's US home institution and they have a school code on the FAFSA form.
  • You often don't need to reside in the state to opt into that state's 529 plan. If there's a chance your child will attend school in that state or that state's plan is particularly favorable, you may want to consider plans outside your state of residence.

Potential Drawbacks of 529 Plans

As with any investment, 529 plans do involve some risk.

First, because each state administers its own 529 plan, each may offer different investment choices and performance may vary. Some states may also charge higher fees which can be a drag on your plan's earnings.

Next, given your funds are invested in the stock market, they'll be subject to some volatility. If your plan isn't properly diversified or adjusted to the appropriate risk level when the beneficiary intends to use the funds, you may risk a market downturn aligning with when you plan to start drawing on those funds.

Another risk to consider is opting for a pre-paid tuition plan without realizing the restrictions on where your child may attend school or whether a state will guarantee the pre-paid tuition plan. While you'd still be able to use the funds, the money may not go as far as you originally intended.


As with any large purchase such as a home or an education, time can be a strong ally to allow for saving, planning and investing. Start today to help your child, grandchild or other family member secure a better future through education.

To learn more about 529 plans, speak to your First Citizens partner.


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