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How do 529 plans work?

Many parents and grandparents are confused about 529 plan rules. A 529 college savings plan is an investment account whereyour money grows tax-free if it’s used to pay for qualified education expenses. This includes college costs, as wellas $10,000 per year in tuition expenses at private, public or religious elementary and secondary schools. Unlike othersavings vehicles, there are no income limits, and no time limits imposed. In our Annual College Savings Survey, we presented six true or false questions about 529 rules to visitors of Savingforcollege.com.Click through the slideshow to see where the biggest misconceptions lie!

1. I must use the 529 plan offered by my state of residence – FALSE

  • 20% of total respondents answered incorrectly
  • 18% of grandparents and 21% of parents answered incorrectly
  • You can enroll in almost any state’s 529 plan, no matter where you live, but your home state many offer a state tax benefitsfor residents.

2. If my child doesn’t go to college, I’ll lose the money I have saved in my 529 plan – FALSE

  • 17% of total respondents answered incorrectly
  • 10% of grandparents and 18% of parents answered incorrectly
  • If the beneficiary of a 529 account doesn’t go to college, you canchange the beneficiary or take a non-qualified withdrawal.
  • If you take a non-qualified withdrawal, you will incur income tax as well as a 10% penalty tax on the earnings portionof the account. You’ll never be taxed or penalized on the principal (the amount you deposited) since it was madewith after-tax money.

RELATED: Avoid these 529 withdrawal traps

3. 529 plan savings must be applied toward colleges in the state where the plan is based – FALSE

  • 16% of total respondents answered incorrectly
  • 12% of grandparents and 17% of parents answered incorrectly
  • You can use your 529 savings to pay for almost any post-secondary education, including traditional four-year universities, community colleges, trade schools andeven study abroad programs. As of January 1, 2018, families can also take a tax-free withdrawal of up to $10,000per year, per beneficiary to pay for tuition expenses at private, public or religious elementary and high schools.

RELATED: 529 plans and K-12 tuition 

4. If my child gets a scholarship, I’ll lose the money I have saved in a 529 plan – FALSE

  • 9% of total respondents answered incorrectly
  • 5% of grandparents and 10% of parents answered incorrectly
  • If a student gets a scholarship, non-qualified 529 plan withdrawals up to the amount of the tax-free scholarship willnot be subject to the 10% penalty. The earnings portion of the withdrawal, however, will incur income taxes.

RELATED:The truth about scholarships and 529 plans

5. Savings in a 529 plan are considered when determining financial aid eligibility – TRUE

  • 33% of total respondents answered incorrectly
  • 37% of grandparents and 32% of parents answered incorrectly
  • Funds saved in a 529 plan owned by a parent or student are considered parental assets. When determining a student’s ExpectedFamily Contribution, a financial aid office will count up to 5.64% of parental assets as funds available to pay forcollege (compared to 20% of student assets).
  • Assets in a grandparent-owned 529 plan are not reported on the FAFSA, but when the grandparent makes a withdrawal topay tuition the amount will be reported as student income on the following year’s FAFSA. Income is assessed at 50%.Withdrawals from parent- or student-owned 529 plans have no effect on financial aid.

RELATED:Yes, your 529 plan will affect financial aid

6. My child can never withdraw from the 529 plan without my permission – TRUE

  • 37% of respondents answered incorrectly
  • 39% of grandparents and 37% of parents answered incorrectly
  • Unlike custodial accounts under UGMA/UTMA, the 529 plan account owner (not the beneficiary) retains control of the fundsthroughout the life of the account. The beneficiary has no legal rights to the assets, regardless of his or her age.
Kathryn Flynn

By Kathryn Flynn

Kathryn is Editor-in-Chief at Savingforcollege.com and is a subject matter expert on 529 plans. Since joining the team in 2014, she has created a variety of content to help families and financial professionals understand the best ways to save for education. She has been quoted in The Wall Street Journal, the New York Times, Fortune and other well-known media outlets.
As a parent, Kathryn practices what she preaches when it comes to saving for college. She has a 529 plan for each of her three children and actively looks for ways to bring down their future college costs.

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