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Best Use of 529 Plans to Save and Pay For College

By David J. Haas CFP®
March 11, 2022
Small Boy holding 529 sign

You might already know that a 529 plan can be one of the most effective savings vehicles for college, but you might not know all it can do or how it can even help you even when your student is in college. Read on to learn more about 529 plans and all their benefits.

529 Basics

First a quick review on what a 529 plan is. The name comes from the section of the IRS code that authorizes them, but the IRS actually calls these plans Qualified Tuition Plans. At a top level, these plans are very simple, but like all things related to the tax-code, the details can be complex. Basically, you contribute money to an account which does not incur income taxes while the money stays in the account. The account is invested. When the family pays for qualified expenses, you can take distributions from the account to pay for those expenses. There is no tax owed on any gains in the account as long as you use the money for qualified expenses, such as tuition, room & board, books, and fees related to higher education.

529 plans must be sponsored by a state. The states have partnered with investment companies to provide these plans and fees, terms, and investments vary with each state’s plan. You are free to use any state plan you wish, but there may be certain advantages, such as state tax deductions, to use the plan in your state. Some states may have sponsored several plans with different providers and other states have not sponsored 529 plans at all.

529 plans as long-term college savings vehicles

The 529 plan can be an excellent long-term college savings account. Even without a state tax deduction, the tax-free compounding helps your savings grow faster than other options. As an example, let’s say you start a 529 plan when your child is born and put $5,000 into it each year. Let’s also say that your money grows 6% each year on-average. By the time your child is 18 years old, you will have $154,528 in the 529 account. This will provide about $40,000 per year towards college and withdrawals from the 529 plan will be tax-free if used for college expenses. It may not solve 4 years at a top-tier university with no financial aid, but it makes a big dent. If your child goes to a great state school, it likely to pay for the whole thing.

529 during college

Obviously, you can use an existing 529 plan to pay for college all 4 years (or beyond). But there can be advantages to continuing to contribute to a 529 plan even though you are going to withdraw from that 529 plan in the same year. The advantages are related to state tax benefits that many states provide for their 529 plan. For instance, if you are a NY taxpayer, you get up to a $10,000 tax deduction on your state taxes for contributing to the state’s 529 plan. If you are going to pay money to a college in 2022, it makes sense to contribute at least $10,000 of that money to a NY 529 plan. Leave the funds in the most conservative investment allocation and then withdraw it to pay the college bill. You will get your tax deduction. NJ now provides up to a $10,000 tax deduction for those making less than $200,000. PA has up to a $32,000 and CT has up to a $10,000 tax deduction for married couples. Even if you had used a different state’s 529 plan prior to college, open a new plan in your state to get the deduction now.


There are a couple of things to be careful of. If you are eligible for the American Opportunity Tax Credit, you can get a $2000 tax credit for the first $2000 of tuition and fees (not room & board) you pay and up to a $500 credit for the next $2000 you spend. Similarly, the Lifetime Learning Credit provides up to a $2,000 credit. But you must not be reimbursed by a 529 plan in order to take these credits. So, make sure you take advantage of the tax credits you are eligible for, prior to taking 529 plan distributions.

In order for your 529 plan distributions to be tax free, they must be used for eligible expenses that are not paid in any other way. This includes the tax credits, scholarships, and loans.

Leftover 529 funds

All parents think their children are brilliant (I know I do)! So, you might be asking, what if my child gets a free ride at Harvard because they are just so smart? What happens to my 529 savings then? 529 plans are extremely versatile and you can change the beneficiary of a 529 plan to another child or another relative. You can even use it yourself to go back to school or pay up to $10,000 per year towards private grade/high school for your other children if you change the beneficiary. As long as the 529 plan is used for eligible expense, distributions will be tax free. If there is truly no one who can use the 529 funds for school, taking a distribution will mean a 10% tax penalty plus any taxes on gains in the account. Remember that your contributions were already taxed, so there is no additional tax on those. The 10% penalty is waived if the reason you can’t use the funds is because your child died, received a tax-free scholarship, received employer assistance for education, attended a military academy, or the only funds needed were used to claim one of the tax credits I already mentioned.

Note that some states have slightly different rules. For instance, NY does not allow 529 plan distributions to be used to pay for primary or secondary education and will require any tax deductions on contributions to be paid back. Interestingly, the NJ College Affordability Act which instituted NJ’s tax deduction in 2022 did not include the requirement to pay back the tax deductions. I also do not believe distributions for primary and secondary education are free of NJ taxes. Other states vary.

529 Plan is an Excellent Tool

I think the 529 plan is an excellent tool to save for college. Because it is tax free and because 529 plan balances are considered parent assets and only counted at 5.64% for needs-based financial aid, 529 plans are superior to other savings and investment accounts for college savings. They even have benefits while your student is in school. Designing a college savings plan or creating a plan to pay for college are just two of the services we perform for our clients at Cereus Financial Advisors. Our College Money Match service helps you choose colleges to maximize aid and create a plan to pay for it. See more at or

The information provided is for educational and informational purposes only, does not constitute investment advice, and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. Investing is inherently risky. Information is based on sources we believe are accurate, but we cannot guarantee accuracy. You should consult your attorney or tax advisor. See more disclosures here: Disclosures

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