How 529 Plans Can Help Save for the Future

It’s no secret that the cost of a college education has risen sharply over the past few decades. The cost of tuition, fees, and room and board to attend a four-year college full time was $10,231 in 1980, according to information from the National Center for Education Statistics reported in a May 9, 2023, Forbes article. That number increased by an eye-popping 180% to $28,775 for the 2019-2020 school year.

One investment vehicle that families can use to prepare for the rising costs of college are 529 plans. These plans—sponsored by states, state agencies and educational institutions—are investment accounts that offer tax benefits when the money is spent on qualified education expenses for the beneficiary.

Also, families using 529 plans to help pay for college can use a new feature in 2024 to help beneficiaries save for the future beyond graduation. As part of the SECURE Act 2.0, which was signed into law in December 2022, beneficiaries will be allowed to roll the 529 plan into another tax-advantaged account, the Roth IRA. Roth IRA accounts help people save for retirement because contributions grow tax free and can’t be withdrawn without penalty until the account holder is age 59.5.

How Do 529 Plans Work?

529 plans can help pay for K-12 education, apprenticeship programs, postsecondary education, and two- and four-year college degrees.

Though there are different types of plans, 529 plans are similar to a Roth 401(k) or Roth IRA in that after-tax contributions are invested in mutual funds, exchange-traded funds and other investment vehicles.

This video on saving early and investing for longer-term goals includes a segment on two types of 529 plans. The video is part of a series from the St. Louis Fed in cooperation with the SIFMA Foundation.

Some 529 plan benefits and restrictions, according to the U.S. Securities and Exchange Commission and Saving for College, an independent resource for families, include:

• Once invested, money in a 529 plan grows tax-deferred and is not subject to federal income tax when put toward qualified education expenses.
• Contributions are not deductible from federal income taxes, but some states offer tax deductions or tax credits on 529 plan contributions.
• Most states set lifetime contribution limits of $235,000 to $550,000—Missouri’s is $550,000—though there is no annual limit.
• However, if families take out money from the 529 account for noneducation expenses, they must pay tax on the plan’s income in addition to a 10% penalty.

Because of these tax benefits, 529 plans can offer advantages when compared with traditional methods of saving for college, such as savings accounts or other investments. When deciding on a 529 plan, be sure to read the specific rules and regulations for the plan, according to Saving for College. Fees and expenses will differ depending on the plan.

How Much Can a 529 Plan Save for College?

To help visualize how much 529 plans can help families save for college, see the general examples below using typical averages from Saving for College.

The Smith family starts a 529 plan with an original investment of $1,000 in 2023 when their child is born. From now until 2040, the Smiths contribute $250 monthly into the plan to prepare for the education expenses of their child (the beneficiary). Assuming a 7% rate of return on the plan, the Smiths are projected to save $101,376, nearly $49,000 more than a taxable account would total.

Another family, the Joneses, start their child’s 529 plan with a $5,000 original investment in 2023. After that, they invest $500 every month into the account. With a 7% rate of return on the plan, the 529 is projected to have $212,580 by 2040, substantially more than the $108,642 that a taxable account would total.

Exact saving amounts and returns will vary by 529 plan, but these examples offer a general idea of how much plans can help in saving for the future.

New for 2024

Beginning next year, 529 plans will have a new feature due to legislation signed into law by President Joe Biden in December 2022. In 2024, families can roll unused 529 funds into a Roth IRA without incurring a tax penalty.

While more detailed rules are expected to be released by the end of 2023, the Roth IRA account must be for the beneficiary of the original 529 plan and not the account owner, such as a parent.

In addition, the original 529 plan account must be 15 years old before it can be rolled into a Roth IRA, according to a Feb. 15, 2023, U.S. News & World Report article. The article outlined other requirements, including that the lifetime limit for funds moved from a 529 plan to a Roth IRA is $35,000 per beneficiary and contributions made to the 529 plan within the last five years cannot be moved into a Roth IRA.

While standard Roth IRA limits still apply—in 2023, the limit is $6,500—there is no income restriction on eligibility.

The new provision gives families another benefit to setting up 529 accounts for their children. Not only can the accounts help pay for the ballooning costs of a college education, they can also be used as a vehicle to save for their future after they complete their education.