How to Pay for Baby’s Education with a 529 Plan

Holding a newborn baby for the first time may be priceless, but supporting a child for 18 years is not. In fact, the Brookings Institution puts the average cost of raising a child over $300,000. And that’s only taking into account the first 17 years.

By the year 2037 (when today’s toddlers will be starting college), state schools could cost almost $225,000 and private college costs may come in just shy of $500,000 according to Northwestern Mutual.

As a grandparent, godparent, aunt, uncle or family friend, you might want to help financially support new parents by contributing to future education costs. The gift of knowledge may not be as shiny as a new bike or as adorable as a stuffed animal, but it will make a meaningful impact on baby’s future.

Why You Might Not Want to Give Cash or Savings Bonds

In the past, it was extremely common for family and friends to give cash or savings bonds. But things are changing.

The problem with cash is that when you put it in an envelope, there’s no guarantee that the money will make its way into a savings account. And even if it does, plain old savings accounts don’t generate much interest. The average US savings account has an interest rate of just 0.24 percent according to the FDIC.

Although savings bonds were once seen as being “the go-to for college savings,” they are no longer as attractive as they once were, says Tara Elwell Henning, founder of Superkin, an organization that hosts a popular workshop called “Financial Planning for Families and Caregivers.” Bonds will yield a better return than savings accounts—and they are still a good option for some—but they are trickier to purchase and use as a long-term investment. You can purchase between $25 and $10,000 in bonds each calendar year through your bank, credit union or through the TreasuryDirect website. However, giving funds to the baby or child in your life through a 529 might be a better option.

What’s a 529 Plan?

A 529 plan is a state-run, tax-advantaged savings plan that can be used to help pay for education fees. Think of it as less of a savings account and more of an investment account that gives you tax benefits while you collect money for education.

You can open an account for anyone and use up to $10,000 a year for educational expenses from kindergarten through college. 529 plans can also go toward expenses related to home school, continuing education, trade school and vocational school. In many states, you can deduct 529 contributionsfrom your state taxes and include them with your annual gift tax exclusion.

There are many ins and outs of 529 plans, including potential future impacts on financial aid packages. So if you are planning to make a major contribution (or a number of smaller contributions over time), it’s worth considering long-term financial planning for education.

While a 529 plan is considered one of the best ways to save for college, as of January 2024, a new policy has lifted the limitations on what the funds invested in a 529 plan may be used for, expanding options. If your child decides they don’t want to go to college or choose to attend a more affordable community college or trade school, the money isn’t lost. You can now roll the money over into a Roth IRA tax-free after 15 years (with a limit of $35,000).

What Are the Tax Benefits of a 529 Plan?

At the federal level, 529 plans can grow tax-free, and you won’t have to pay federal income tax on funds that you withdraw for qualified educational expenses like tuition, housing and books. This includes up to $10,000 on K-12 tuition or student loans.

Additionally, more than 30 states offer income tax deductions or credits when you contribute to a 529 plan; the amount of the deduction or credit varies based on where you live and how much you contribute. (If you want to find out about the tax benefits you get by having a kid, we have that too.)

Note: You are not limited to your home state’s 529 plan. You can shop around and find the state plan that best fits your needs.

What Are The Different Types of 529 Plans?

According to Minna Black, founder of In the Black Wealth, there are two types of 529 plans.

The prepaid plan offers the option of buying tuition credits and using them in the future at an in-state public college or university. “Essentially you get to lock in the cost of college at today’s prices,” she said.

The second type of 529—the savings plan—is the investment plan, and you contribute funds on behalf of a beneficiary to be invested based on a portfolio that you choose.

How to Set Up a 529 Plan

Anyone can set up an account for baby through your state or with a financial advisor. Here’s how:

1. Select a state-run 529 plan. You may want to consider past performance and fees. Note: lower fees make more of an impact when a child is young, and state income tax breaks are more significant once the child enters high school.
2. Decide if you will open an individual account (with the parent as the account holder) or a custodial account (which is owned by the child and likely managed by you or another adult). Because funds in a parent-owned account are considered an asset and funds from a custodial account are considered student income, the type of plan you choose will impact future financial aid.
3. Visit the website of the 529 plan you selected and download the enrollment kit, or use this handy Enroll Now tool. You will likely need to have this information about the account holder and beneficiary: name, mailing address, telephone number, email address, date of birth and Social Security Numbers (SSN) or Individual Taxpayer Identification Numbers (ITIN).

Warning: The sheer number of available 529 account options can feel overwhelming–you can select a plan from any state and some states have more than one plan available. Luckily, SavingForCollege.com has comparison charts, personalized advice and a variety of tools and resources, including a list of special considerations for grandparents.

What Are the Advantages of a 529 Plan?

Many people are drawn to 529 plans because of the income tax breaks they offer. Earnings can grow federally tax-free and they will not be taxed when withdrawn to pay for college. 529 plans also have high contribution limits and they can reduce your estate taxes. Plans are flexible, low maintenance and ensure that your contribution is being used for educational purposes.

How Do I Contribute to a 529?

You can add money to your 529 account by transferring money electronically from your bank or by mailing a paper check. Options include one-time payments, recurring payments or payroll contributions.

You can contribute to virtually every already-existing 529 plan by check. Make the check payable to the 529 plan and add the beneficiary’s name and account number.

If you would rather not ask for baby’s account number, you may prefer to purchase a gift card through platforms like Gift of College. You can buy this gift card online and email it to the parents, or if you want to give a physical gift, you can find Gift of College gift cards in a wide variety of stores like CVS and Walmart. Minimum contributions are as little as $25. Parents can redeem these gift cards for any current 529 plan, any new 529 plan or any existing student loan account.

Parents may be more willing to connect with gift givers through free-to-use services like Ugift, which can share a unique code with family and friends who want to send monetary contributions to celebrate milestone events. Minimum contributions can be as little as $15.

You can give up to $15,000 ($30,000 as a couple) each year without incurring gift taxes or using up part of your lifetime gift tax exclusion.

Commonly Asked Questions About 529 Plans

Can I set up a 529 for an unborn child?

Yes. Technically, you can only set up a 529 account for a living beneficiary with a Social Security Number. However, you can change the beneficiary at a later date. So you could open a 529 account with the expectant parent as a beneficiary, and switch the beneficiary to the baby once their Social Security Number has been issued. It’s a smart decision you can make as you prep for baby.

Can I set up a 529 for my grandchild?

Yes. You can either set up a custodial account for your grandchild that you manage or an individual account that one of your grandchild’s parents manage.

Can I set up a 529 for my nephew or niece or a friend’s baby?

Yes. Grandparents, aunts, uncles, godparents, family friends–anyone can set up a 529 plan for a child. However, in many cases it is more convenient to contribute to an already-existing account if the child has one.

How much should I contribute to a child’s 529?

The short answer is that you can contribute as much or as little as you want. There are a number of different strategies you may want to employ based on the age of the child. You can also calculate the projected cost of college and use an online 529 calculator to determine the amount.

But in the end, you should contribute whatever you can comfortably afford.

Do you need a 529 for each child?

No. You can use one combined 529 plan for all of the children in the immediate family. Before making your final decision, review the pros and cons.

How do you manage a 529?

The only time you will have to manage a 529 account is if you open a custodial account (in which you own the account and you designate a beneficiary). That means that you will be selecting an investment strategy and deciding when to withdraw funds. You may want to take more risks when the child is young and make more conservative decisions when they are closer to college age.

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You might be all in on forgoing tangible gifts for education planning. You could be ready to sign up right now to gift money on birthdays, holidays or at the conclusion of each school year.

But it’s also understandable that you may have some reservations about showing up to a five-year-old’s birthday party with a paper gift certificate announcing your contribution. After all, it would be way more exciting to show up with a giant Barbie Dream House. If that’s the case, consider giving a smaller monetary contribution combined with a modest gift. You’ll have the thrill of being a great gifter both now and in the future.

And remember that regardless of the level of your contribution, the gift of knowledge and experience lasts a lifetime.