What is a 529 (Qualified Tuition) Plan?

A 529 Plan, legally known as a “Qualified Tuition Plan,” is a type of investment account that encourages saving for future education costs. Authorized by Section 529 of the federal tax code, this plan allows you to defer paying taxes on the money in the account as it grows. Furthermore, you can generally withdraw the money tax-free as long as you use it for qualified educational expenses, as defined by the IRS.

529 plans were limited initially to use for post-secondary education.  However, recent expansions allow you to use the funds for K-12 private school tuition, for apprenticeship programs, and to repay student debt.

Other savings vehicles, like mutual funds, are subject to taxation during growth and upon withdrawal. But the tax breaks available with 529 plans are a unique incentive to save.

How does a 529 plan work?

First, it’s important to note that although 529 plans take their name from the federal tax code,  individual states, state agencies, or educational institutions sponsor them.  The state in which they’ve handles the administration.

There are two types of 529 plans: prepaid tuition plans and education savings plans.

Both types are not necessarily available in all states. However, all fifty states and the District of Columbia sponsor at least one type of 529 plan.

A group of private colleges and universities also sponsor a prepaid tuition plan.

What is a prepaid tuition plan?

The specifics of 529 prepaid tuition plans vary from state to state, and there are also prepaid tuition plans, such as in Massachusetts, that are not 529 plans.

Still, the principle is broadly the same: contributing to a 529 prepaid tuition plan allows you to lock in future tuition at current rates, thus avoiding rising costs and inflation. They also usually offer the same tax break benefits as any 529 plan. What’s more, in many cases, your savings are transferrable or refundable if your child attends a different school than planned.

There are some drawbacks, as well. Prepaid tuition plans don’t cover as many costs as other options. For example, this type of plan often does not cover room and board, supplies, and equipment.

The federal government does not guarantee prepaid plans, and there may be other restrictions, such as on residency for the saver and beneficiary. There may also be limits on participating universities, whereas education savings plans offer more flexibility.

How does a 529 savings plan work?

Savings plans are the more common type of 529 plan.

They can offer more options compared to prepaid tuition plans. Under a 529 education savings plan, qualified expenses include tuition, fees, room and board, and related costs.

Again, specifics differ state-by-state, but withdrawals from a savings plan are typically applicable at any college or university—even some outside the U.S.

You can also use them for K-12, whereas prepaid tuition plans are limited to college. (Note that 529 plans do limit tax-free withdrawals for K-12 students to $10,000 per year.) Finally, 529 savings plans offer a wide range of investment portfolio options and risk profiles.

Some of your 529 savings investments are even insurable by the FDIC. However, Investments in mutual funds or ETFs are not federally guaranteed. State governments do not guarantee investments in 529 savings plans, either.

There are limits to any 529 plan

Some restrictions apply to both prepaid tuition and education savings plans. For example, while there are no limits on how much you can contribute annually to a 529 account, many states place a cap on how much you can contribute in total.

And don’t forget—you will only receive the tax benefits if you use your withdrawal for qualified educational expenses.

What is a Coverdell Education Savings Account (ESA)?

A Coverdell Education Savings Account (ESA) is a tax-deferred trust or custodial account that allows you to save money for your child’s future education.

Formerly known as an “education IRA,” Coverdell ESAs are similar to 529 plans in that they allow your savings to grow tax-free.

There are some important distinctions, though:

  • A Coverdell ESA places a $2,000 annual limit on the total amount contributed to any one beneficiary. 
  • Your individual adjusted gross income exceeds $110,000 ($220,000 if married), you cannot use a Coverdell ESA. For couples. 
  • 529 plans limit you to the investments offered by the plan, whereas Coverdell ESAs allow you to choose specific investments that you like. 
  • When you use a 529 plan to pay for K-12 education, you can only pay for tuition. A Coverdell ESA can help pay for other expenses, as well.

When comparing Coverdell accounts to 529 plans, there are advantages and drawbacks to each. That’s why you may want to consider utilizing both types of savings vehicles, as you can contribute to both plans in the same year.

Custodial accounts (UTMA/UGMA)

Uniform Transfer to Minor Act (UTMA) and Uniform Gift to Minor Act (UGMA) accounts are important options to consider.

These custodial accounts allow you, or another responsible guardian or custodian, to administer a savings account on behalf of the beneficiary (the future college student).

UTMA and UGMA accounts are very similar to each other. Both allow you to maintain complete control of the account until your child is a legal adult. With both accounts, money deposited becomes your child’s property and can only be used for their benefit.

And both allow you to transfer funds to your child without using a trust.

The most crucial difference between these two custodial accounts is the age at which they mature: up to age 18 for UGMA accounts and up to age 25 for UTMA accounts.

For other differences, see the table below.

Differences between UGMA and UTMA accounts

Maturity Date Up to age 18. Up to age 25.
Tax Benefits  The first $1,050 is tax-free. The second $1,050 is taxed at the child’s tax rate. The first $1,050 is tax-free. The second $1,050 is taxed at the child’s tax rate.
Allowable Assets for Transfer Cash, securities, and insurance policies. Any kind of asset
Eligible Expenses Any expense that benefits the child. Not limited to education. Any expense that benefits the child. Not limited to education.
Financial Aid Impact Counted as child’s income when applying for financial aid. Counted as child’s income when applying for financial aid.
Contribution Limits None None
Termination Date Age 18 Age 21


There are no contribution limits for UTMA/UGMA accounts. These accounts also offer more flexibility; the funds can be used for anything. When it comes to saving for college, this can be a significant advantage. Your 529 plan will not help you pay for non-qualified expenses, like application or testing fees, transportation costs, healthcare, and more.

The flexibility of UTMA/UGMA accounts can also present drawbacks. For example, control of these custodial accounts transfers to the beneficiary upon legal adulthood. With nothing forcing your child to spend those savings on college expenses, you may find they use the money in ways you didn’t plan for or expect.

Each of the three college savings vehicles I’ve outlined here provides different tax advantages, as well as various pitfalls and drawbacks. Ultimately, the best strategy for you will depend on your location, income, and circumstances.

But one thing is true across the board: with college getting more expensive all the time, it is never too early to start saving.

If you face college tuition at some point in your future, we can help you think through the alternatives and plan your savings.  Just contact us here.

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