How to Start a 529 Savings Plan

A 529 plan is a specialized, tax-advantaged plan designed primarily for college expenses. While you don't get a tax deduction on contributions to a 529 plan, you can take the money out tax-free if used for allowable expenses. It's not mandatory that you use funds in a 529 plan for educational expenses, but you may face taxes and penalties if you withdraw the funds for other purposes.

Types of Plans

There are two types of 529 savings plans, a prepaid plan or an investment plan. With a prepaid plan, you lock in the cost of college at the current rate, no matter how high it might go in the future.

With an investment plan, a 529 operates more like a college-focused 401(k) plan. These types of plans offer mutual fund-like investment options you can use to try to maximize your return. Whatever money you earn by the time you're ready to withdraw it is what you get to keep.


You can choose any beneficiary you would like for a 529 plan you establish, making it one of the most flexible types of savings plans available. You're also free to change the beneficiary at any time -- for example, if one of your children wins a scholarship and you want to shift the savings to their sibling. You even can name yourself the beneficiary of the plan.

Opening a 529 Account

Open a 529 account either through an adviser or directly through a plan issuer. With several thousand 529 options available, including different options in every state, many investors prefer to get assistance from a financial professional. However, if you do your own research, you can open a plan directly -- often online -- by completing the new account paperwork and making a contribution. If you open an account directly, you may be able to bypass commissions charged by financial advisers.


You can fund your account simply by sending in a check to the plan administrator. If you prefer to make monthly payments, you can instruct your bank to send transfers automatically to the plan, or you may be able to set up automatic deductions from your paycheck.

Unlike some other retirement or savings plans, you can make a contribution to a 529 plan no matter how high your income is, making it attractive to high-income taxpayers. There also are no limits on who can contribute to a 529. However, to avoid gift tax, the amount of your contribution is limited to the current annual gift tax exclusion amount, $14,000 as of 2015. A special provision in the tax code does allow individuals to essentially pre-pay five years of contributions as one lump sum. For example, if the current gift tax limit is $14,000, you could make a one-time $70,000 contribution. After five years have passed, you could resume making annual contributions.


  • While you can technically exceed the gift tax exclusion amount, you'll either have to file a complicated gift tax return and claim that amount against your lifetime gift exemption or pay gift tax at a rate of up to 40 percent.

Tax Benefits & Penalties

The main tax benefit offered by 529 plans is the ability to take tax-free withdrawals if used to pay for qualifying college expenses, such as tuition, room and board or school supplies. If you contribute to an in-state 529 plan, you also may get a state tax deduction, although this benefit varies from state to state.

If you decide to withdraw the money for a non-qualifying purpose, you'll owe ordinary income tax on the earnings you withdraw. You'll also owe a 10 percent penalty. Your contributions can come out tax- and penalty-free at any time. The taxes and penalties on earnings also come into play if you take out too much money, as you're only allowed to withdraw an amount equal to the necessary educational expenses for the year of withdrawal.

About the Author

John Csiszar earned a Certified Financial Planner designation and served for 18 years as an investment counselor before becoming a writing and editing contractor for various private clients. In addition to writing thousands of articles for various online publications, he has published five educational books for young adults.