Saving for a child’s education can feel overwhelming, especially with the rising cost of tuition. A 529 plan is one of the most popular ways to set aside money for future education expenses, offering tax advantages and flexible investment options. But like any financial tool, it has its drawbacks.
Before opening a 529 plan for your child or grandchild, it’s important to understand both its benefits and limitations. This guide breaks down the key pros and cons of 529 plans to help you decide if it’s the right choice for your family’s education savings.
Pros and Cons of 529 Plans
Pros |
Cons |
Tax benefits: Earnings grow tax-free, and withdrawals for qualified expenses aren’t taxed. Many states also offer tax deductions or credits. |
Penalties for non-qualified withdrawals: If funds are used for non-education expenses, earnings are subject to income tax and a 10% penalty. |
High contribution limits: Unlike Roth IRAs or Coverdell ESAs, 529 plans allow large contributions (varies by state, up to $500,000+ in some cases). |
Must be used for education: While some exceptions exist (e.g., student loan repayment, Roth IRA rollovers), funds are generally limited to education-related expenses. |
Minimal impact on financial aid: Considered a parental asset, so it only counts up to 5.64% for financial aid calculations, unlike custodial accounts (20%). |
Ownership rules can be tricky: The account owner—not the beneficiary—controls the funds, which can be an issue in cases like divorce or reliance on a grandparent’s account. |
Flexibility: Funds can be used for college, K-12 tuition (up to $10,000/year, in some but not all states), student loans ($10,000 lifetime), and now Roth IRA rollovers ($35,000 max). |
State tax deduction limitations: Not all states offer tax benefits, and some require you to use their state’s plan to qualify. |
Age-based investment options: Many plans automatically adjust from aggressive to conservative investments as the beneficiary nears college age. |
Limited investment choices: Unlike self-directed investment accounts, you must choose from the plan’s pre-set investment options. |
Easy to manage: Automatic contributions, online management, and low-maintenance investment options make it simple for busy families. |
Potential fees: Some plans charge management fees or advisor fees, which can reduce overall savings. |
Advantages of Using a 529 Plan to Save for Education Costs
Let’s look at 529 plans’ pros and cons, starting with their advantages.
Tax advantages
Investing in a 529 plan has a range of tax benefits. 529 plan investments grow on a tax-deferred basis, and distributions are tax-free when used to pay for qualified education expenses, including college tuition and fees, books and supplies, some room and board costs, up to $10,000 in K-12 tuition per year, and up to $10,000 in student loan repayment per beneficiary and per sibling.
As of 2024, beneficiaries of a 529 plan can now roll over up to $35,000 tax-free to a Roth IRA in their names, subject to certain limitations.
In most cases, states exclude qualified 529 plan distributions from taxable income, and many offer a state income tax deduction or credit for 529 plan contributions. 529 plans are the only college savings plans to offer state tax deductions and credits.
States may have residency requirements for tax breaks, but families are not restricted to their home state’s plan. An exception may be if they are using a prepaid tuition plan.
Low Maintenance
A 529 plan account can be opened online or through a licensed financial advisor. Families who prefer to “set it and forget it” can select an automatic investment plan linked to a bank account or payroll deduction plan. The program manager handles the ongoing investment management within a 529 plan.
For added convenience, 529 plans offer age-based or year-of-enrollment investment options. If you choose to invest in one of these, the investments will automatically shift from more aggressive, equity-based investments to more conservative, fixed-income, and cash investments as your child approaches college age. This strategy initially allows for the potential of higher returns while gradually prioritizing wealth preservation as the enrollment date approaches.
High Contribution Limits
When a dependent student or their parent owns a 529 plan, it is reported as a parental asset. Unlike other savings plans, such as a Roth IRA or Coverdell Education Savings Account (ESA), 529 plans have no annual contribution and offer high aggregate limits. Maximum aggregate limits vary by state, ranging from $235,000 to more than $500,000.
The IRS considers 529 plan contributions completed gifts to the designated beneficiary for tax purposes. In 2025, up to $19,000 qualifies for the annual gift tax exclusion (up from $18,000 in 2024). There is also an election to contribute as much as $95,000 in one year without generating a taxable gift if the contribution is treated as if it were spread over five years.
Favorable Financial Aid Treatment
When a dependent student’s parent or a dependent student owns a 529 plan, it is reported as a parental asset. It has a relatively minimal effect on financial aid eligibility compared to UGMA or UTMA custodial accounts. 529 plans are assessed at a maximum of 5.64% of their value in the FAFSA calculation, while custodial accounts are assessed at 20% to 25%, making a big difference in aid eligibility.
Distributions from 529 accounts owned by other family members or loved ones are not counted as income on the Free Application for Federal Student Aid (FAFSA).
Additional uses beyond college expenses
If your child decides not to attend college, you still have several ways to use 529 plan funds. You can use them for other education expenses, including student loan repayment, rolling over up to $35,000 into a Roth IRA, or covering K-12 tuition. Each option has specific rules and limits, so be sure to review the guidelines before making a decision.
Flexibility
529 plans offer the same advantages for all families, regardless of household income or contribution amount. You can invest in almost any 529 plan, no matter where you live or your child will attend college.
Disadvantages of Using a 529 Plan
Along with the upsides, there are also a few disadvantages of 529 plans.
Penalty for Non-Qualified Withdrawals
Non-qualified distributions are subject to income tax and a 10% tax penalty on the earnings portion of the distribution. However, there are exceptions to the penalty if the beneficiary gets a scholarship, attends a U.S. Military Academy, dies, or becomes disabled.
State Income Tax Recapture
If a 529 plan account owner does a rollover into another state’s 529 plan, any state income tax deductions and credits previously claimed may be subject to recapture, and the earnings portion of the outbound rollover may be added back to state taxable income.
Limited Investment Options
A 529 plan account owner must select from the plan’s investment options. These typically include static investment portfolios that aim to achieve a targeted level of risk, individual fund portfolios, and age-based portfolios that automatically shift asset allocation as the beneficiary gets closer to college.
Fees
The more families pay in 529 plan fees, the less they can save. Direct-sold 529 plans are less expensive than advisor-sold 529 plans, but expenses can also vary among 529 plan portfolios. Researching your options and finding a low-cost 529 plan option that meets your education savings needs is essential.
Ownership rules
The 529 plan account owner, not the beneficiary, has legal control of the money in the account. The account owner can easily change the beneficiary at any time, or worse, they can take a non-qualified distribution and liquidate the plan. This might become an issue in case of divorce or if a parent depends on a grandparent or other relative’s 529 plan to pay for their child’s education.
Is a 529 plan right for you?
To choose the best option for you, there are a few things you should consider when weighing 529 plan advantages and potential drawbacks:
- Are you planning to use the funds exclusively for education savings?
- How much do you need to save for college, grad school, K-12, or apprenticeship programs?
- What state do you live in?
529 plans can only be used to fund education expenses. Otherwise, you’ll face penalties. On the other hand, 529 plans have high contribution limits, offer significant tax savings, and have a limited impact on financial aid.
