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What is a 529 Plan? 529 Plan Pros and Cons

The 529 plan is a student education savings plan initiated by the state of Michigan in 1986, and this plan allows students to save for their tuition without attracting income tax under Section 529 of the Internal Revenue Code.

by Damodharan N

Updated Apr 16, 2024

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What is a 529 Plan? 529 Plan Pros and Cons

What is a 529 Plan?

The 529 plan is a tax-advantaged education savings plan known as a qualified tuition program. It was first implemented by the state of Michigan in 1986. In 1996, it was added as a part of the Small Jobs Protection Act, and Section 529 of the Internal Revenue Code was implemented.

In which tax benefits were given to qualified state government education savings programs that would not attract federal or state income tax. The program is quantified based on the expenses and type of education.

For higher education expenses like tuition, fees, books, supplies, and equipment required for enrollment or attendance, along with digital material needs like software, computers, and internet access for special beneficiaries, students' needs can also be covered.

In the case of secondary and elementary education, a tuition fee limit of $10,000 per year is allowed. The 529 plan is broadly categorized into two types: education savings plans and prepaid tuition plans. Let's know how they work in detail below. 

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Types of 529 Plans  

As we already know, the 529 plan has two types of qualified tuition programs. They are education savings plans and prepaid tuition plans. each of them offers unique requirement and savings need.

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Education Savings Plans

The education savings plan is crafted by state governments, with some requiring residency for savers and beneficiaries. This plan covers tuition, mandatory fees, and room and board. In this plan, one can also get benefits for non-US colleges.

In this plan, a tuition fee of $10,000 per year is allowed for elementary or secondary school. The program is now run by 49 states in the US and the District of Columbia in one manner or another.

In simple economic terms, savings are directly correlated to investments, so this education savings plan offers various fund options like principally protected bank products, mutual funds, exchange-traded funds, and portfolio funds like static fund portfolios, age-based portfolios, or target-based portfolios.

Each of these funds comes with its pros and cons. All the funds are not protected by the FDIC; only some principal-protected bank products are insured by them. This plan comes with a set pre-investment and allows only twice to change investment options.

this type has an enrollment/application fee, a maintenance fee, and an asset management fee based on the investment option. So savings in the education fund require some knowledge of investment options and going through the various state government plans before choosing the right ones. 

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Prepaid Tuition Plans

It is more like saving now at current prices for your tuition fees and mandatory fees for a particular college in the hope that your child will get into that college and complete the course. In the event of a rise in tuition fees and mandatory fees, you will still be charged at the old price, as you have technically prepaid them like your mobile phone bills.

If they are not going to attend the said college, then their contribution amount will be reduced, and only a small portion of it will be given to you as part of the plan. This plan does not offer a last-minute flexibility option.

In certain cases, the money saved in this scheme is not guaranteed by all the state and federal institutions in case of financial hardships for sponsors. So this plan will be suitable for those kids' parents who are absolutely sure that their kids won't change their minds when they graduate from high school about their plans and also choose the plan where some state governments offer guarantees.  

Tax rules for 529 Plans

The tax rules for 529 plans stem from Internal Revenue Code Section 529. The code species who are beneficiaries and who can open this on behalf of the child. What qualifies for the education expenses, and which education institution qualifies for them? like that code, enshrines all the norms and regulations. 

  • In certain states, a tax break is allowed if you are a resident of that state.
  • The money that is being contributed is not federally tax-deductible. but if it is used for purposes other than qualified education expenses, then a 10% penalty will be levied. 
  • Taxes are not applicable, like gift tax, if the amount contributed is less than the annual gift tax exclusion and if it seems to be a qualified education expense.
  • Estate tax is not applicable if it is used for qualified education expenses. But in certain scenarios, you will be taxed, which is explained in Section 529(c)(4)(B) and (C). which takes into account the beneficiary rollover and excess contribution in a particular calendar year. 

529 Plan Pros and Cons

The 529 plan is made for students to have some sort of savings for students who cannot access education due to tuition fees, and it will be applicable only for education expenses. 


  • All the money withdrawals will be exempt from the federal income tax based on qualified education expenses.
  • Most plans have low contribution levels, so this plan is suitable for low income levels. 
  • Assets within this plan are protected under bankruptcy. 
  • Many plans offer a maximum contribution of $250,000 or more.
  • This plan offers tax-deferred growth.
  • Some foreign colleges are also eligible for this plan. 


  • This plan should only be used for education expenses; if it is used for anything else, a 10% tax will be levied as a penalty.
  • This plan offers higher maintenance costs compared to other savings, like asset maintenance fees.
  • This plan offers less flexibility in terms of investment savings options like funds and mix fund investments.
  • Fees for accessing this plan can vary based on the state boundary, and in certain states, they require beneficiaries to be residents.
  • What terms as qualified education expenses need to be updated regularly, like half-yearly or annually, as the nature of education expenses is changing rapidly. 

What is a 529 Plan - FAQs

1. What is a 529 plan?  

It is a qualified tuition program in which beneficial individuals have to either prepay or contribute to an account for savings on education expenses.


2. What are the types of 529 plans?  

There are two main categories: education savings plans and prepaid tuition plans.

3. How many funds are available in education savings plans?  

The Education Savings Plans offer various funds like principally protected bank products, mutual funds, exchange-traded funds, and portfolio funds like static fund portfolios, age-based portfolios, or target-based portfolios.

4. Which type is most suitable for a flexible investment option?  

The most suitable flexible investment is education savings plans, which offer more funds.

5. What are the biggest benefits of the 529 Plan?  

The biggest benefit is income tax deferment under both state and federal income taxes. If the fund is used only for qualified education expenses.

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