What Is a 529 Savings Plan?

Families need to save as much as possible, as early as possible to get ahead of rising education costs. According to a research report from CollegeBoard.org, the average cost of attending a public four-year college, including tuition and fees, in the 2021 to 2022 school year is $10,740 for an in-state student and $27,560 for out-of-state students. A year at a private college averages even more: $38,070.

Named after the section of the Internal Revenue Service (IRS) code that established them, 529 savings plans are one of the nation’s best ways to save for higher education expenses. These qualified tuition plans allow federal tax-free withdrawal of earnings and the potential for tax deductions, which can help families afford the rapidly increasing cost of college.

A primary benefit of 529 plans is the high contribution limit. Each state operates its own 529 plan and makes its own rules for the plan, so maximum contribution levels vary across states. Fortunately, 529 limits are usually high enough that most will never have to worry about hitting the ceiling, although anyone who considers attending a private university could need to save a significant amount of money.

How a 529 Plan Works

A 529 plan allows investors to save and grow money on behalf of a beneficiary, such as a child, grandchild, niece, nephew, or even for themselves. The money grows tax-free and can be withdrawn tax-free, provided it is used for qualified higher education expenses (QHEE). These include tuition and fees; certain electronics, such as a computer; books and classroom equipment; and some room and board costs.

Plan distributions that are used to pay for items that are not QHEE are subject to state and federal income taxes and an additional 10% federal tax penalty on earnings, with exceptions made for certain circumstances, such as death and disability.

There are two main types of 529 plans: prepaid tuition plans, in which the plan holder pays in advance for the beneficiary’s tuition and fees at a specific school, and savings plans, which are tax-advantaged investment vehicles similar to individual retirement accounts (IRAs). 

How Are 529 Contribution Limits Determined?

To qualify as a 529 plan under federal rules, plan balances cannot exceed the expected cost of a beneficiary’s QHEE. The generally accepted guideline is that this limit constitutes five years of tuition, room, and board at the most expensive college in the United States.

This guideline makes investment contribution limits quite large, although every state is allowed to individually interpret what five years of qualified education costs means. Potential contributors can check their states’ 529 limits to determine specific investment maximums.

State-Specific 529 Contribution Limits

Every state’s 529 plan allows for maximum contributions of at least $235,000 per beneficiary. Georgia and Mississippi have the lowest maximum balance limits at $235,000, followed by North Dakota at $269,000.

On the high end, states such as Idaho, Louisiana, Michigan, and Washington, as well as the District of Columbia, have maximum limits of $500,000. Pennsylvania’s limit is $511,758, South Carolina’s and New York’s are both $520,000, and California’s is $529,000. Once the limit is reached, any contributions made to the account are not accepted and will be returned to the investor.

These contribution limits apply to each beneficiary. For example, in Georgia, which has a $235,000 maximum contribution limit, if parents contribute $200,000 for a beneficiary, grandparents cannot also contribute $200,000 for the same beneficiary.

However, contribution maximums generally do not apply across states. An investor hitting the maximum in one state would likely be eligible to contribute more money in another state’s plan. To be safe, individuals should check with plan administrators first to make sure this is allowed.

Limit for Repaying Student Loans

Under the SECURE Act of 2019, you can also use a 529 plan to pay off up to $10,000 of your existing student loan debt. Note that this $10,000 limit is a cumulative lifetime limit.

Gift Tax Considerations

Normally, annual contributions to any individual above a certain threshold ($15,000 in 2021 and $16,000 in 2022) would count against your $12.06 million (or $24.12 million for married couples) lifetime gift tax exemption.

However, there is an exception made for contributions within a 529 plan. In 2022, for example, grandparent can give an $80,000 one-time lump-sum contribution to a 529 plan with the understanding that it would cover five years’ worth of gifts. As long as that person doesn’t contribute again in the next five years, there are no tax consequences.