About 529 plans: Education savings with tax benefits

Young children who will enjoy the benefits of a 529 Plan when they go to college

Among the many options available for college and education savings, a 529 plan offers flexibility, tax benefits, and other distinctive features.

If you’re like many working-age adults with children, you’re striving to save for college education costs while also setting back funds for your retirement.

With higher education costs on the rise, getting a jump-start on college savings is often a practical idea. A 529 plan can be a great way for families to set aside money for their student's future education costs and get ahead on savings while enjoying tax benefits, flexibility, and more.

529 plan standard features and benefits

  • Tax-deferred contributions and tax deferral on any growth
  • Federally tax-exempt withdrawals for qualified expenses* such as tuition, fees, and books (possibly exempt from state taxes too)
  • Flexibility to change beneficiaries—if one child chooses not to go to college, you may designate the funds to another child or even future grandchildren.
  • Full control of the money as the account holder

529 plans come in two flavors

  • Prepaid tuition plans let the account holder purchase credits (and sometimes room and board) at eligible colleges and universities, locking in tuition prices ahead of time. Residency restrictions may apply.
  • College savings plans allow greater flexibility in how and where the funds can be used, allowing for expenses such as mandatory fees, room and board, and textbooks, without designating a particular school.

Because there are differences between the two plans, it's worth doing your homework to see what works best for your student.

Keep in mind also that 529 plan structures vary by state. Because you're allowed to open a 529 savings plan offered by any state, shop around for the plan that best suits your needs.

"Be sure you fully understand your plan before signing up," says Jason Heffner, senior financial services representative with Principal®.

Considering saving for college with a Roth IRA instead?

College savings plans may suit your situation better than a Roth IRA or other savings or investment plan, so it's worth reviewing your options. Consider that:

  • 529 plans don't have the annual income restrictions that Roth IRAs do, so you can make contributions even if your household income is high.
  • The plans' contribution limits are quite high, so you can typically contribute much more than you can to a Roth IRA.
  • 529 plans have low minimum contribution levels that help make them affordable for households with smaller incomes.
  • Funds in a 529 plan are considered an asset of the account owner, not the student, and typically won't impact the student's request for financial aid.

Make the most of your 529 plan

  • Start early, add often. Consistency is key to a successful plan, says Heffner. He suggests contributing to the account on a monthly basis to stay on track.
  • Review your plan regularly. Heffner suggests reviewing your 529 plan annually and making adjustments as needed.
  • Continue saving for retirement. “Save for retirement first and college second," says Heffner. "It's possible to take out loans for education, but not for retirement."
  • Sit down with a financial professional and discuss all the choices available to you for college savings. Principal can help.
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* Earnings on nonqualified distributions (those that don't meet the requirements of qualified expenses) are taxed as ordinary income and may be subject to a 10% federally mandated penalty.