529 College Savings Plan

A 529 college savings plan is an investment vehicle that allows for a tax-advantaged way to pay higher education costs.

A 529 plan is a tax-advantaged account that helps U.S. investors stretch their college-savings dollars further. Contributions (money put into the account) are made with aftertax dollars, but once money is invested in the account, it grows tax-free, and money taken out of the account is not taxed when the money is used for qualified educational expenses.

Compared with other college savings vehicles, 529s have a more minimal impact on financial aid eligibility. On top of that, some states offer tax deductions or credits for contributions.

How 529s Work

529s allow you to invest in stocks and bonds using preset investment menus, either age-based or static. Age-based plans automatically shift from more aggressive, like higher-earning stocks to less risky investments, like bonds, as your child nears college, while the static portfolio remains the same.

How to Choose a 529 College Savings Plan

Plans are administered at the state level, and some states offer an income tax benefit for contributing. 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. If your state offers either a tax deduction or a credit, especially if it offsets all or most of the in-state plan's fees, strongly consider using your state's plan. If your state doesn’t offer a tax benefit or has no income tax, there's no benefit to staying in state. College savers in these states can search for the best plan, whether in-state or out of state. The same is true for college savers who live in so-called tax-parity states, which offer a state tax benefit for contributing to any state’s 529 plan.

Morningstar rates 529 plans to help you choose the best option, whether you're evaluating plans across states or within one state. We award plans that we like with Morningstar Analyst Ratings of Bronze, Silver, or Gold, with Gold-rated plans having our highest conviction.

Here are some of the most important considerations when evaluating 529s:

Glide Path: How an age-based plan shifts to less-risky investments as your child nears college. We like plans with smooth transitions from stocks to bonds and cash as opposed to dramatic shifts.

Underlying Holdings: A high percentage of funds earning Morningstar Medalist ratings implies higher quality. State Oversight and Plan Management Quality: We want to see experienced managers overseeing the asset-allocation and investment-selection processes.

Fees: We evaluate a plan's all-in expenses, which means that we look not only at administrative fees and plan-management fees, but we also evaluate the costs of the underlying investments.

There are two primary forms of 529 plans:

Prepaid tuition plans are those that involve a contract in which the contract’s parties either pay a lump sum or installments of the total cost of tuition for a college at today’s cost (with potential adjustments for expected tuition changes) that the college then invests in order to match the predicted amount of cost by the time the child enrolls.

Educational savings plans function similarly to a personal investment account in which the plan’s constituents choose a portfolio of investments to contribute to. Over time the investments are expected to grow so that by the time the student enrolls in college, they can withdraw funds from the plan to pay for education costs.