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 plan. 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.

What kinds of 529 plans are there?

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.

What are the 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 2019, a beneficiary can receive up to $15,000 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 allows a maximum account balance of at least $235,000 with California allowing up to $529,000.

How can the money in a 529 plan be used?

The 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.

How does the 529 plan affect 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. 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 independent. If a student receives a distribution from the plan for qualified education expenses, that amount is not treated as 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%. 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.

In general, the tax and gift advantages of a 529 savings plan make them an excellent way to save 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 service mark of the US Department of Education.