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Cash for College: Tax-Free 529 Plans

Written by a TurboTax Expert • Reviewed by a TurboTax CPAUpdated for Tax Year 2024 • December 16, 2024 11:59 AM
OVERVIEW

With a 529 plan, you can stack up the books, not the debt. No matter how old your child is, it might be time to consider a qualified tuition program (QTP), also known as a 529 plan. For many families, such a plan offers a more convenient way to save money for college.

A young person laying in bed reading a book.

Key Takeaways

  • With a 529 plan, contributions aren't federally tax-deductible, but your investments grow tax-free, and withdrawals for qualified educational expenses don't incur federal taxes.
  • You can choose a 529 plan from any state, not just your own, which allows you to pick the one that best fits your needs. You can also change beneficiaries or roll over assets to another plan as your educational savings needs evolve.
  • When selecting investments for your 529 plan, focus on options with low fees and high performance to align with your financial goals and risk tolerance.
  • Start saving early to benefit from compounding growth, set up automatic contributions to ensure regular savings, and encourage family and friends to contribute as gifts.

 

A great way to save

First they wanted toys, then computers. Now they want to go to college. The cost of raising children adds up, and rising college tuition multiplies the headaches triggered by a family’s already-dwindling bank account.

But planning ahead can prevent a future of sleepless nights—tossing and turning as you fret over education expenses—and graveyard diner shifts for your financially struggling student.

No matter how old your child is, it might be time to consider a qualified tuition program (QTP), also known as a 529 plan. For many families, such a plan offers a more convenient way to save money for college.

“I want my daughter to have enough money to go through school without taking out loans,” said Terri Knight, who works in the financial aid office at Red Rocks Community College in Lakewood, Colorado. “It is a proactive way to save for college,” referring to a 529.

Working in financial services at a college helped Knight see the importance of starting early. Her daughter is only 3 years old, but by the time she’s ready to leave the nest, her mother will have built up a nice nest egg for tuition costs.


"Five twenty-nine plans are tax-advantage programs that help families save for post-secondary education. ... We personally think it’s one of the best things that Congress has ever done," says Patricia M. Kane, senior financial adviser, Connecticut Wealth Management.


Why a 529 plan?

Named for Section 529 of the Internal Revenue Code, most 529 plans are operated by individual states, which can offer prepaid tuition and savings plans under the program. Some educational institutions can also offer prepaid tuition 529 plans, although Kane said that most investors opt for the savings plan, since identifying a higher-education institution for a young child can be a challenge.

“Five twenty-nine plans are tax-advantage programs that help families save for post-secondary education,” said Patricia M. Kane, senior financial adviser for Connecticut Wealth Management. “That’s it in a nutshell. And the savings can be used not just for college, but for trade school, culinary school, graduate school, even private K-12 tuition—there’s a list of opportunities. We personally think it’s one of the best things that Congress has ever done.

”A major benefit of 529 savings plans is that, although contributions are not tax-deductible at the federal level, the interest is not subject to federal tax. As long as the money is used only to pay for qualified educational expenses for the designated beneficiary—the student named as the beneficiary of the plan—the money taken out is also tax-free. On many states' tax forms, contributions are partially or fully deductible, but most require that the plan be taken out in the contributor's home state to get the deduction.

With the prepaid tuition option, taxpayers can lock in current tuition rates at qualified in-state public educational programs, even if the future student is still in diapers. But keep in mind that the student or the student’s family will have to make up the difference for out-of-state programs, which can cost substantially more than in-state tuition—double or triple the amount in some cases, depending on the school.

TurboTax Tip:

You can use funds from your 529 plan for a wide range of educational expenses, including tuition, books, computer equipment, and room and board, keeping withdrawals tax-free as long as they're for qualified expenses.

Is setting up a 529 plan complicated?

The Internal Revenue Service has a web page and a variety of publications designed to help taxpayers determine if a 529 plan is right for them. The most complicated aspect is likely to be choosing from the variety of options.

Every state offers at least one 529 plan. The plans vary from state to state, and you may take out a plan in any state you choose, regardless of where you live and what institution your student will eventually attend. For example, you may live in California, take out a 529 plan in Colorado and send your student to a school in Massachusetts. It all depends on which state plan offers the benefits you want.

“The best place to start is with your own state,” said Kane, “because your own state will often have tax advantages for you.”

Once you’ve determined how to take full advantage of your state's tax benefits, Kane suggests that you look at other states’ plans as well. “Your state’s plan may not be as cost-effective or high-performing,” Kane said, “All plans have fees. Low fees and high performance are the keys.”

Remember, a 529 plan is an investment. Many states offer several types of plans, ranging from safe to aggressive, so individual taxpayers may determine the best fit for their finances.

While the range of choices might seem overwhelming, each state has a website offering detailed information on its plans. Once you choose the program, you may make contributions and watch the account grow. And because anyone may contribute to the fund, grandparents, aunts, uncles and even friends may help give the gift of a higher education.

What's the catch?

While there’s no “catch,” you should keep some things in mind. The money in a 529 savings plan has been limited to use for higher education costs only up until 2018. Beginning in 2018, 529 plan funds can be used for K-12 tuition as well. If you take money out for other reasons, you might be subject to a 10 percent penalty as well as taxes on your withdrawal.

Kane noted, however, that there must be earnings in the account for you to be penalized for a withdrawal. “If it hasn’t performed well, there are no penalties,” Kane said. “You only pay penalties on earnings, not on the principal if you take this out.”

Another consideration is gifting limitations. The federal government establishes limits on how much each individual may contribute to a 529 plan per year, and any amount above that can be subject to gift tax. For 2024, the tax-free contribution limit for each individual is $18,000 per beneficiary. Couples filing taxes jointly may contribute a total of $36,000 per year per beneficiary without paying gift tax. These amounts increase to $19,000 and $38,000, respectively, for 2025. States can have limitations on contributions as well, but “those numbers are usually very large,” said Kane.

So, why not a 529 plan?

“These plans are very popular, but people have been reticent to put money in because the markets had not been performing well in the past,” said Denis Horrigan, a principal of Connecticut Wealth Management.

“But by saving money outside of a 529 plan, you’re losing the benefits of tax deduction and earnings. And 529 plans are both a great college savings tool and a great estate planning tool.”

An attractive aspect of a 529 plan is that it allows you to remove assets from your estate while you remain in control. “We think that’s one of the best features of a 529 plan,” Kane said. “You can roll over your assets from one plan to another. You can change beneficiaries. You control your investments.”

And as new IRS policy allows 529 plan funds to be used for the purchase of computer technology, including equipment and Internet access, you can even buy your college-bound student that new laptop.

A 529 plan at tax time

What happens at tax time when you’ve taken money out of your 529 plan to pay for higher-education expenses? The procedure is simple.

When you pay for expenses, including tuition, books, computer equipment, and room and board, the school in which your beneficiary is enrolled issues a Form 1099-Q documenting the expenses, explained Patricia M. Kane, senior financial adviser for Connecticut Wealth Management. The state that carries your 529 plan will issue a 1099 documenting how much you have withdrawn from the plan.

You file this form with your taxes. The IRS will also have a copy and will match these expenses with what you have withdrawn from your 529 account. When those expenses match up, you’re home free—and tax-free.

If your individual contributions to a 529 plan exceed the allowable maximum set by the IRS, you must file Gift Tax Form 709. With regard to state taxes, your own state and the state in which you carry your 529 plan have specific guidelines that you may consult to determine any forms to be filed.

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  • 1099-NEC Snap and Autofill: Available in TurboTax Premium (formerly Self-Employed) and TurboTax Live Assisted Premium (formerly Self-Employed). Available in mobile app only. Feature available within Schedule C tax form for TurboTax filers with 1099-NEC income.

  • Year-Round Tax Estimator: Available in TurboTax Premium (formerly Self-Employed) and TurboTax Live Assisted Premium (formerly Self-Employed). This product feature is only available after you finish and file in a self-employed TurboTax product.

  • Refer a Friend: Maximum of $500 in total rewards for 20 referrals. See official terms and conditions for more details.

  • Refer your Expert (Intuit's own experts): Maximum of $500 in total rewards for 20 referrals. See official terms and conditions for more details.

  • Refer your Expert (TurboTax Verified Pro): Maximum of $500 in total rewards for 20 referrals. See official terms and conditions for more details.

  • Average Refund Amount: $3,207 is the average refund amount American taxpayers received in the 2024 filing season based upon IRS data as of February 16, 2024 and may not reflect actual refund amount received. Each taxpayer's refund will vary based on their tax situation.

  • More self-employed deductions: based on the median amount of expenses found by TurboTax Premium (formerly Self Employed) customers who synced accounts, imported and categorized transactions compared to manual entry. Individual results may vary.

  • TurboTax Online Business Products: For TurboTax Live Assisted Business and TurboTax Full Service Business, we currently don't support the following tax situations: C-Corps (Form 1120) and entities electing to be treated as a C-Corp, Trust/Estates (Form 1041), Tax Exempt Entities/Non-Profits, returns that require more than 5 state filings, and other issues unrelated to the preparation of a tax return or unrelated to business income/franchise taxes. TurboTax Live Assisted Business is currently available only in AK, AZ, CA, CO, CT, DE, FL, GA, ID, IL, KS, MA, MD, ME, MI, MN, MO, NC, NJ, NV, NY, OH, PA, RI, SD, TN, TX, UT, VA, WA, WV, and WY.

  • Audit Defense: Audit Defense is a third-party add-on service provided, for an additional fee, by TaxResources, Inc., dba Tax Audit. Audit Defense is included at no added cost with business returns filed with TurboTax Live Business (excluding Sole Proprietor). See Membership Agreements at https://www.intuit.com/legal/terms/ for service terms and conditions.

TURBOTAX DESKTOP GUARANTEES

TurboTax Desktop Individual Returns:

  • 100% Accurate Calculations Guarantee - Individual Returns: If you pay an IRS or state penalty or interest because of a TurboTax calculation error, we'll pay you the penalty and interest. Excludes payment plans. This guarantee is good for the lifetime of your personal, individual tax return, which Intuit defines as seven years from the date you filed it with TurboTax Desktop. Excludes TurboTax Desktop Business returns. Additional terms and limitations apply. See License Agreement for details.

  • Maximum Refund Guarantee / Maximum Tax Savings Guarantee - or Your Money Back - Individual Returns: If you get a larger refund or smaller tax due from another tax preparation method by filing an amended return, we'll refund the applicable TurboTax federal and/or state software license purchase price you paid. This guarantee is good for the lifetime of your personal, individual tax return, which Intuit defines as seven years from the date you filed it with TurboTax Desktop. Excludes TurboTax Desktop Business returns. Additional terms and limitations apply. See License Agreement for details.

  • Audit Support Guarantee - Individual Returns: If you receive an audit letter from the IRS or State Department of Revenue based on your 2024 TurboTax individual tax return, we will provide one-on-one question-and-answer support with a tax professional, if requested through our Audit Support Center, for audited individual returns filed with TurboTax Desktop for the current 2024 tax year and, for individual, non-business returns, for the past two tax years (2022, 2023). Audit support is informational only. We will not represent you before the IRS or state tax authority or provide legal advice. If we are not able to connect you to one of our tax professionals, we will refund the applicable TurboTax federal and/or state license purchase price you paid. This guarantee is good for the lifetime of your personal, individual tax return, which Intuit defines as seven years from the date you filed it with TurboTax Desktop. Excludes TurboTax Desktop Business returns. Additional terms and limitations apply. See License Agreement  for details.

  • Satisfaction Guarantee/ 60-Day Money Back Guarantee: If you're not completely satisfied with TurboTax Desktop software, go to refundrequest.intuit.com within 60 days of purchase and follow the process listed to submit a refund request. You must return this product using your license code or order number and dated receipt. Desktop add-on products and services purchased are non-refundable.

TurboTax Desktop Business Returns:

  • 100% Accurate Calculations Guarantee - Business Returns: If you pay an IRS or state penalty or interest because of a TurboTax calculation error, we'll pay you the penalty and interest. Excludes payment plans. You are responsible for paying any additional tax liability you may owe. Additional terms and limitations apply. See License Agreement  for details.

  • Maximum Tax Savings Guarantee - Business Returns: If you get a smaller tax due (or larger business tax refund) from another tax preparation method using the same data, TurboTax will refund the applicable TurboTax Business Desktop license purchase price you paid. Additional terms and limitations apply. See License Agreement  for details.

  • Satisfaction Guarantee/ 60-Day Money Back Guarantee: If you're not completely satisfied with TurboTax Desktop software, go to refundrequest.intuit.com within 60 days of purchase and follow the process listed to submit a refund request. You must return this product using your license code or order number and dated receipt. Desktop add-on products and services purchased are non-refundable.

TURBOTAX DESKTOP DISCLAIMERS

  • Installation Requirements: Product download, installation and activation requires an Intuit Account and internet connection. Product limited to one account per license code. You must accept the TurboTax License Agreement to use this product. Not for use by paid preparers.

  • TurboTax Desktop Products: Price includes tax preparation and printing of federal tax returns and free federal e-file of up to 5 federal tax returns. Additional fees apply for e-filing state returns. E-file fees may not apply in certain states, check here for details. Savings and price comparison based on anticipated price increase. Software updates and optional online features require internet connection. Desktop add-on products and services purchased are non-refundable.

  • Fastest Refund Possible: Get your tax refund from the IRS as fast as possible by e-filing and choosing to receive your refund by direct deposit. Tax refund time frames will vary. The IRS issues more than 9 out of 10 refunds in less than 21 days.

  • Average Refund Amount: $3,207 is the average refund amount American taxpayers received in the 2024 filing season based upon IRS data as of February 16, 2024 and may not reflect actual refund amount received.

  • TurboTax Technical Support: Customer service and technical support hours and options vary by time of year.

  • Deduct From Your Federal Refund: Individual taxes only. Subject to eligibility requirements. Additional terms apply. A $40 Refund Processing Service fee applies to this payment. method. Prices are subject to change without notice.

  • Data Import: Imports financial data from participating companies; Requires Intuit Account. Quicken and QuickBooks import not available with TurboTax installed on a Mac. Imports from Quicken (2022 and higher) and QuickBooks Desktop (2023 and higher); both Windows only. Quicken import not available for TurboTax Desktop Business. Quicken products provided by Quicken Inc., Quicken import subject to change.

  • Live Tax Advice: Access to tax experts to obtain answers to tax questions and to assist with tax year 2024 return(s) prepared with TurboTax Desktop software. Additional fees apply. Must be purchased and used by October 31, 2025. Excludes TurboTax Desktop Business. See License Agreement for details.

  • Audit Defense: Audit Defense is a third-party add-on service provided, for a fee, by TaxResources, Inc., dba Tax Audit. See Membership Agreements at https://turbotax.intuit.com/corp/softwarelicense/ for service terms and conditions.

All features, services, support, prices, offers, terms and conditions are subject to change without notice.

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