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Special Report

What Is a 529 College Savings Plan?

Learn how a 529 plan can help pay for certain educational expenses. 

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There are a few ways to save for college, and one of the most often used is the 529 college savings plan, also known as a 529 education savings plan. 529 plans have become popular vehicles for college savings because they allow a significant amount of money to be saved, and they have money-saving tax advantages when used properly. 

In this guide, you'll find what you need to know about 529 savings plan options as a potential or current accountholder and how to take that first step to set up a plan and start saving. 

We’ll answer frequently asked questions about 529 plans and check off the main considerations that should drive your 529 plan selection. We've also included excerpts from our annual list of 529 plan ratings to help you find the best option for your situation. 

What Is a 529 Plan?

Let’s look at the basics of a 529 plan. A 529 college saving plan is an investment vehicle that allows for a tax-advantaged way to pay higher education costs. 

With a 529 plan, you can contribute aftertax dollars into an account that then grows tax-free and can be withdrawn tax-free to cover qualified educational expenses like tuition, mandatory fees, books, a computer, internet access, and room and board. 

You can also use a 529 plan to pay for grad school, trade school, and, in some places, even K-12 private education.  

After all the educational expenses are covered, you can transfer the remaining funds to some family members including parents, siblings, step-siblings, first cousins, and even some in-laws. 

Types of 529 Plans 

When it comes to 529 plans, we group states into five categories. The first two allow state tax breaks on your 529 contributions while the remaining three provide no tax incentive for staying in-state. 

  • Tax Parity: You get state income tax benefits for contributing to any state's 529 plan.  
  • Tax Credit: This is a percentage of your 529 contribution that directly reduces your state income tax bill. (If you get a 10% credit for up to $2,000 in state income taxes, you slash $200 from your bill by contributing at least $2,000.) Unlike a deduction that lowers the amount of income subject to tax, a credit is a dollar-for-dollar reduction in your tax bill.  
  • Tax Deduction: You can subtract part or all of your 529 contribution from your income subject to state income taxes. (In other words, a $5,000 deduction on $100,000 in taxable income leaves $95,000 of your income subject to state income taxes.) 
  • No Benefit: Your state doesn't provide a state tax benefit for contributions to any 529 plan. 
  • No Income Tax: You live in a state with no state income taxes. 

  •   - source: Morningstar Analysts and state websites.

    How Do I Choose a 529 Plan?

    Certain states offer tax benefits for their 529 plan. However, if your state does not offer attractive tax benefits or another state’s 529 plan is more appealing, you may be able to contribute to that 529 plan instead. 

    529 plans are administered at the state level, so they vary by state in terms of asset allocation, investment quality, and fees. Thankfully, many states allow out-of-state residents to invest in their plans, which opens a lot more options for college savers. And while having more choices is good, evaluating all those options can prove time-consuming and difficult. 

    To help make that process a little more manageable, here are some steps you can take to find the right 529 plan for you.  

    Step 1: Evaluate your state tax benefit. 
    State income tax benefits are a big consideration when determining whether you should stay in-state or venture out-of-state to find a 529 plan.  

    We might currently rate your state’s 529 plan(s) poorly, but if your contributions (money put into the account) earn a state tax break that you would forgo by venturing out-of-state, in most cases you will benefit from staying. You should be aware that there can a wide range to the dollar value associated with state tax benefits. Be sure to do your research in advance.  

    Step 2: Determine if you want an age-based or static portfolio. 
    Once you decide whether or not to stay in-state, it's time to make some investment decisions. Decide which of the two broad 529 investment options you prefer: age-based/target enrollment or static portfolios.  

  • Age-based or target enrollment portfolios—The most popular choice among investors, age-based portfolios automatically shift from risky, higher-earning securities (stocks) to less-risky investments (bonds) as your child nears college. This helps protect your money from being wiped out in a market downturn shortly before you'll need to pay tuition bills. If you choose an age-based portfolio, understand how they vary across plans. 
  • Static portfoliosStatic portfolios let you choose what to invest in. The holdings stay the same over time unless you adjust them, letting you cook your own college-savings meal with ingredients from a preset investment menu. This includes stock funds, bond funds, and balanced funds, which contain a set proportion of stocks and bonds. But keep in mind that accountholders are allowed to make only two investment changes per year. (Note: Static portfolios are best-suited for those who want to deviate from an age-based portfolio and have the time and knowledge to tinker with the portfolio over time.) 
    • Step 3: Use Morningstar's research to compare plans. 
      Morningstar rates 529 plans to help you choose the best option whether you are evaluating plans across states or within one state.  

      In 2021, when 529 education savings assets crossed the $400 billion mark and reached $437 billion by August, our analysts reviewed 62 plans representing 97% of those assets. Of this cohort, 32 received a recommended rating in the form of a Morningstar Analyst Rating of Gold, Silver, or Bronze. 

      Morningstar Medalist plans offer investment options that we expect will collectively outperform and exhibit some combination of the following attractive features: 

      • A well-researched asset-allocation approach. 
      • A robust process for selecting underlying investments. 
      • An appropriate menu of options to meet investor needs. 
      • Strong oversight from the state and investment manager. 
      • Minimal fees. 

      Families invested in these 529 plans should be well-positioned for the future. 

      Picking a 529 plan is a very nuanced decision, and every investor has different consideration to keep in mind. To help decide whether or not you should stay in state, read more of our insights to see if the tax break is worth it.  

      To see how your plan rates compared with other states, take a look at what our researchers consider the top 529 education savings plans available right now.

      Where Are 529 Contributions Tax Deductible?

      There are a lot of choices out there if you’re shopping for a 529 plan. To help you narrow the options, tax incentives can be the biggest deciding factor, and they vary by state.  

      For example, Washington, D.C., and 32 states provide additional tax incentives by allowing families to deduct their 529 contributions from their taxable income calculation. But there are several inputs to consider when estimating the tax benefits at the state level.  

      For simplicity, let's consider a couple filing jointly with an annual income of $100,000 who deposits $3,000 a year (or $250 a month) into one beneficiary’s 529 account. Using each state's personal marginal income tax rate for this hypothetical couple, the annual estimated tax savings range from $48 to $269. At the low end, Rhode Island's maximum tax benefit is $48 a year, as the state tax deduction limit is low, at $1,000 per taxpayer. (The marginal tax rate for a couple making $100,000 is 4.8%.) 

      For those who can save a lot more, certain states provide very generous tax benefits. New Mexico, South Carolina, and West Virginia have no deduction limits. If the same family earning $100,000 saves $5,000 a year for each of their three kids, they can deduct $15,000 from their income, resulting in tax savings of $885, $1,050, and $975, respectively. 

      Seven states--Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana, and Pennsylvania--offer a much less restrictive benefit called tax parity, which means that investors are allowed to take a deduction on state income taxes on contributions made to any plan in the United States (most states only allow you to take a deduction if you invest in the state-sponsored plan). 

      To learn what tax benefits exist for 529 plans in other states, refer to our full list of 529 ratings.  

      Additional 529 Plan Resources

      529 savings plans can make a significant difference in setting families up for success, but the terrain can be difficult to navigate. If you’d like to learn more about 529 plans, read some other related content that our researchers have provided: