Saving Smart: Don’t Fall for the Top Five Myths about 529 Plans

When you become a parent, you start getting all kinds of unsolicited advice: to sleep train or not, private school or public, free-range childhood or coding camps. And saving for college is no different. You’ve probably heard that 529 plans are a powerful tool for saving for college. Contributions can grow and be withdrawn tax free as long as the proceeds are used to pay for qualified expenses, which can provide a significant boost when facing the soaring cost of college.

But friends, family, even the internet will offer you well-intentioned advice that may not be best suited to your situation. At Commas, we’re here to help you separate fact from fiction so you can determine the best course of action for your family.

Keep an eye out for these five myths about 529 savings plans.

Myth: “Your child won’t qualify for as much student aid if they have a 529 account.”

Fact: Putting money in a 529 won’t substantially affect your child’s college financial aid package. If the 529 account is held by a parent or the child, then less than 5.64% of those assets will count toward your expected family contribution, a key metric used in calculating a student’s reward.

Myth: “You can only use a 529 account for college tuition.”

Fact: Assets held in a 529 can be withdrawn tax- and penalty-free for a wide range of educational expenses.

First, these funds can be used to pay for many kinds of college costs, including

  • Housing, meal plans (often including off-campus equivalents)
  • Required educational supplies, including paper, pens, textbooks, computers, software, and other necessary supplies. (Be sure to check your school’s budget limit, as it can vary between institutions.)
  • Internet services
  • Special needs equipment and transportation

Assets in 529 plans can also be used to pay educational costs for more than just four-year colleges, including

  • Vocational and trade school (“two-year schools”) tuition and fees
  • $10,000 per student per year towards elementary or secondary school tuition
  • $10,000 lifetime limit in student loan payments

Myth: “You have to use your state’s 529 plan.”

Fact: You can participate in any 529 plan. Although 529 plans are organized by states, most plans are available nationwide to all U.S. citizens and resident aliens who are of legal age. However, a few 529 plans are open only to residents of their states.

Many states offer tax deductions or credits to residents who contribute to their state plan. Check out your state plan’s tax benefits, but don’t just assume a tax break makes it the best choice. Some 529 plans offer very limited investment options, and additional fees and expenses can negate your potential tax savings. So be sure to evaluate how the entire plan fits your unique financial situation. The following tools can help you make the best choice for your family:

If you hold a 529 in one state, it is usually not beneficial to roll it into a new 529 account. That’s because some states treat outbound rollovers as non-qualified distributions, so you could owe state income tax on any earnings you’ve generated. Additionally, you might also have to repay any state income tax break you received.

Myth: “You can only contribute a certain amount to a 529 per year, like with an IRA or 401k plan.”

Fact: There are no annual contribution limits for 529 plans. You can contribute as much as you like each year, as long as you don’t go over the state specific contribution limits for that account (ex. $500k in CO). This handy table from SmartAsset provides current 529 plans contribution maximum by state.

It’s worth noting that contributions to 529 plans are considered gifts when it comes to estate taxes. So, if you have a large net worth and anticipate owing estate taxes, you should check into the specific gift tax rules.

Myth: “A 529 is wasted if your child receives a scholarship.”

Fact: If your child receives a scholarship, taxes and penalty fees on plan assets can be waived. First, remember that you can use 529 assets to cover a range of expenses beyond tuition, including housing, meal plans, and required equipment—items often not covered by scholarships. So, a 529 plan can still provide help to a scholarship recipient.

If you were to use a 529 plan to cover costs it wasn’t intended for, then you will owe ordinary income taxes and a 10% penalty. However, both are calculated only on the earnings your account has generated, and not your principal.

Crucially, penalty charges are waived if your child receives a full or partial scholarship. Other exceptions include attending a U.S. military academy or receiving assistance through a qualifying employer plan. In these cases, you can withdraw up to the amount of the benefit you or your child received without penalty. If you withdraw more than that amount, the excess will be penalized.

Paying for college is expensive, and no one wants to see their child go into debt. And, trust us, your children don’t want you to dip into your retirement savings to pay for their college, either. The most important truth about a 529 account then is a simple one: the sooner you open one, the better.