18+ Pros And Cons Of 529 Plans (Explained)

A 529 plan is a tax-advantaged investment instrument. It is designed to encourage saving for a designated beneficiary’s future higher education costs.

In the recent past, K–12 public, private, and religious school tuition was included as scheduled expenses for 529 plans and higher-secondary education costs post-Tax Cuts and Jobs Act. Initially, it was limited to post-secondary education expenses.

As per law savings plans grow tax-deferred, and withdrawals are tax-free if they are used for scheduled education expenses. 529 plans are two basic types of savings plans and prepaid tuition plans. 

Advantages of 529 PlansDisadvantages of 529 Plans
Tax benefitsPenalty for non qualified withdrawals
Low maintenanceState income tax recapture
High contribution limitsLimited investment choices
Favorable financial aid treatmentFees and charges
FlexibilityOwnership rules
Options when selecting a plan

Advantages of 529 Plans

Tax benefits

529 plan investments depend on a tax-deferred basis and distributions are not taxable when used to spend for qualified education expenses like college tuition and fees, supplies and books, some room and board costs above 10K in senior secondary tuition per year and above 10K in student loan repayment per beneficiary and per child.

In majority of cases, states exclude eligible 529 plan distributions from taxable income, and several states offer a state income tax credit or state income tax deduction for 529 plan contributions.

529 plans are the only college savings plan which offers state tax benefits. 

States do have residency requirements for tax benefits, but families are not stopped to use their home state’s college savings plan. An exception may be if they are having a prepaid tuition plan. 

Low maintenance

A 529 plan account can be opened through a licensed financial advisor or online. Families who choose to set it and forget it can choose an automatic investment plan linked to the bank account or a deduction from the payroll plan.

The current investment management within a 529 plan is managed by the program manager.

High contribution limits

Unlike other savings plans like a Coverdell Education Savings Account or Roth IRA, 529 plans have no annual investment limits and high overall limits. Maximum aggregate limits differ by state, from USD 250K to USD 529K.

529 plan contributions are taken as completed gifts to the scheduled beneficiary for tax purposes. In FY21-22, up to USD 15K qualifies for the yearly gift tax exclusion.

There are elections to contribute as much as USD 75K in a year without generating a taxable gift if the investment is considered as if it were spread over five years.

Favorable financial aid treatment

When a parent of a dependent student or a dependent student has a 529 plan, it is taken as a parental asset and has a comparatively minimal effect on financial aid eligibility.

Contributions from parent and student-owned accounts are not considered as income on the Free Application for Federal Student Aid (FAFSA).


529 plans offer a similar advantage for all families, irrespective of their household income or the amount they invest.

No matter where one lives or where their child shall attend college one can invest in any 529 plan. People across all income levels can contribute to a 529 plan and moreover, they have a high contribution limit as most plans have contribution limits of USD 300K and above.

The funds in a 529 savings plan may be used to pay the entire cost of graduate school or college or K-12 tuition expenses up to USD 10K a year. Residents of any state can invest in 529 savings plans. 

Options when selecting a plan

There are two basic types of 529 plans prepaid tuition plans and savings plans. In prepaid tuition plans, one can lock in current tuition rates at state public institutions.

If their child selects to go to an out-of-state or a private institution, one may receive only a small return on their original investment. Whereas in a savings plan one can contribute regularly and rely on the account’s earnings to grow.

One can take on more investment risk while giving their child the opportunity to use the funds at private and public schools nationwide.

Disadvantages of 529 Plans

Penalty for non qualified withdrawals

Non qualified distributions are taxable and the earnings portion is subject to a penalty of 10% on the distribution. However, if the beneficiary gets a scholarship, attends a U.S. Military Academy, dies or becomes disabled there are exceptions to the penalty.

One must be aware that if they withdraw more than USD 14K in a year to pay for tuition fees that could subject to the IRS gift tax.

One may knew they have a tuition bill getting reasonable and withdraw the amount from their savings plan without having a second thought. A qualified education expense may incur during the same year of the withdrawal.

For additional safety one should talk with their 529 plan provider before making a withdrawal for an approved expense.

State income tax recapture

If a 529 plan account owner does a rollover into 529 plan of another state, credits previously claimed may be subject to recapture and any state income tax deductions and the earnings portion of the outbound rollover can be added back to state taxable income.

Limited investment choices

A 529 plan account owner has to select from scheduled investment options prescribed by the 529 plan.

This usually includes static investment portfolios which aim to get a targeted level of risk, individual fund portfolios and age-based portfolios automatically shift asset allocation as the beneficiary gets closer to college.

A 529 plan is different than a traditional savings account. Money added to a 529 plan can be invested other than simply earning interest, typically in mutual funds, some plans may offer individual stocks or exchange traded funds.

It is an advantage as investing in the market usually yields higher returns than simply earning interest. As the returns compound over time, their money has an opportunity to grow faster.

Fees and charges

The families pay more in 529 plan fees; in turn, they are able to save less for college. Direct sold 529 plans are less costly than advisor-sold 529 plans, but expenses can also differ among 529 plan portfolios.

It is important to research available options and find a low-cost 529 plan option that meets their college savings needs.

Like with any other investment instrument, there are fees inherent to 529 plans. These fees are associated with the individual investments themselves which are held within the plan.

If they choose investments with higher management fees, those fees can easily detract from the returns they are earning. 

Ownership rules

Instead of the beneficiary, the 529 plan account owner has legal control of the account. The account owner can easily amend the beneficiary at any point of time.

They may even take a nonqualified distribution and liquidate the plan. It might become an issue if a parent is depending on a grandparent or other relative’s 529 plan to pay for their child’s college education. 

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