A 529 savings plan is a tax-advantaged way of gifting money to a student to help pay for college expenses and one of the better options available to help save for a child’s college education.

Parents, grandparents, or other relatives who want to give a boost to a child’s future can start a 529 savings plan. 529 plan funds can be used to pay for qualified education expenses, including tuition, room and board, books, fees, supplies, and equipment required to attend college. Keep in mind, however, that 529 plans could have an impact on the amount of student aid received, so it’s important to understand the way these plans work.

Types of 529 Plans

There are two types of 529 plans: prepaid tuition plans and savings plans. These plans are administered by state agencies or educational institutions, and they may be different from one state to the next. There are federal tax advantages to opening a 529 plan, and many states also offer state tax-deferred growth and tax-free withdrawals for qualified higher education expenses. Consult a tax professional about potential tax benefits to determine what you qualify for.

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Benefits of a 529 Plan

Most people who start a 529 plan like the fact that they are gifting money without giving up control over the use of the account. This money can be put into a variety of investment vehicles. The available funds can be used at virtually any accredited US university or college, and some states even offer matching grants and other benefits to participants. They are extremely flexible, with no income limitation. Contributions to 529 plans qualify for the annual federal gift tax exclusion, which means that for 2022, a beneficiary can receive up to $16,000 per person to one 529 account under the federal gift tax exemption. Contributions may be limited annually and cannot exceed the cost of qualified education expenses for the beneficiary. Each state sets a lifetime limit contribution; the lowest maximum account balance is set at $235,000 with some states allowing over a $500,000 maximum account balance.

529 Plan Impact on Federal Student Aid

While each educational institution may treat assets held in a 529 plan differently, it generally reduces the student’s eligibility to participate in need-based financial aid. It also increases the amount a student is able to cover for tuition, which may reduce the amount of money they need to borrow.

A plan owned by a parent is usually reported as a parental investment asset on the Free Application for Federal Student Aid (FAFSA), unless the student is considered independent. (Note that dependency is based on very specific criteria that is set by the federal government. A student can still be considered dependent even if they don’t live at home or if the parents are not paying for college.) If a student receives a distribution from the plan for qualified education expenses, the amount given to the student is not treated as student income for FAFSA purposes.

Since third-party owners—such as grandparents who are not legal guardians—do not complete the FAFSA, distributions to the student may be considered untaxed student income and may reduce student aid by up to 50% of the amount withdrawn. If the grandparents are the legal guardians and not third-party owners, then the 529 plan will be treated as an asset on the FAFSA.

However, new changes to the FAFSA affect the way grandparent 529 plans are considered. For the 2024–2025 school year, students will no longer have to disclose cash support, which means that distributions from grandparent-owned 529 plans will not affect need-based aid for their grandchildren.

In general, the tax and gift advantages of a 529 savings plan make them an excellent way to save and pay for college expenses. Since everyone’s situation is different, be sure to consult a financial or tax advisor so you can make the best decision for your family to get the most out of your 529 plan.

About the Author

Jodi Okun is founder and president of College Financial Aid Advisors. She is also the About.com Money Expert on “Paying for College,” and acknowledged as one of the “Top 30 Social Influencers in Personal Finance & Wealth.” She has been featured in The Wall Street Journal, Mashable, US News & Education and The Huffington Post. The opinions expressed in this article are Jodi’s and do not necessarily reflect the opinions of Discover Student Loans.

 FAFSA® is a registered trademark of the US Department of Education and is not affiliated with Discover Student Loans.