How to Optimize Your 529 Contributions

We know that you want to help set up your loved ones for success. One way to invest in their education while saving on taxes is to contribute to a 529 education savings plan.

Optimizing 529 Contributions

529 plans are state-sponsored education savings accounts that provide tax-free growth when used to pay for  qualified education expenses. There are two types of 529 plans: prepaid tuition plans and education savings plans.

  • Prepaid tuition plans allow investors to purchase credits or units that can be used to cover tuition costs in the future.
  • Education savings plans are investment accounts that can be used to pay for qualified higher education expenses including tuition, fees, room, and board.

Let’s focus on education savings 529 plans, which is the more popular of the two. While 529 plans are a great option for most savers, it is important to understand the basic rules and limitations in order to get the most out of your education savings.

Which 529 plan should I choose?

While 529 plans are state-sponsored, you are not limited to using your own state’s plan. That being said, many states provide tax breaks for residents who contribute to an in-state plan. You are also not limited to choosing just one plan for your student. It is common for grandparents of a student to fund a 529 plan in their home state to take advantage of state tax breaks, while the student’s parents open another plan to take advantage of their own state’s tax deductions, or to participate in a plan with lower fees. When choosing the best 529 plan, you’ll want to weigh any state tax breaks, as well as fees and performance. While taking advantage of your state’s tax breaks may be the best option, be careful not to ignore the compound effect of a plan with high investment fees.

How much can I contribute?

Unlike IRAs, which have standard annual contribution limits, limits for 529 plans are complex. There are no annual contribution limits for 529 plans, but the total balance per beneficiary is limited to the expected amount of future qualified education expenses. This amount ranges from $235,000 to $529,000, depending on the state. If the balance exceeds these limits due to earnings, funds can remain in the plan, but you cannot make future contributions unless the balance falls.

Gift Tax Rules

Although you could technically fully fund a 529 plan in one year, contributions are considered gifts to the beneficiary, which introduces another set of limits. Currently, the gift tax annual exclusion is $15,000 per beneficiary per year. Married couples can give $30,000 per beneficiary per year.

You also have the option to front-load your gifts and contribute five years’ worth of the annual exclusion in one year without incurring gift tax consequences, as long as you do not contribute for the following five years.

As a general rule, you do not want to exceed these annual gift tax exclusion amounts, but due to the lifetime exemption of $11.58 million, you will not necessarily incur gift taxes on the excess contributions.

What can I use the funds for?

You can make tax-free and penalty-free withdrawals from your 529 plan to cover qualified higher education expenses, including:

  • Tuition to an an accredited college or university
  • $10,000 per year for private K-12 tuition
  • Room and board for college students attending at least half-time
  • Certain expenses related to approved apprenticeship programs
  • Up to $10,000 used to cover student loan payments
  • Computers, laptops, printers, and other technology items used for education
  • Books and supplies

Because you don’t pay taxes on earnings, saving in a 529 plan can be extremely beneficial, particularly for those who start saving early and have a large amount of earnings in their account over time.

Non-Qualified Distributions

If you withdraw funds for non-qualified purposes—for example, if your child does not go to college—you will be subject to income tax and a 10% penalty on the earnings. Withdrawals are considered to be made up of partly earnings and partly contributions, per the following equation:

Contribution ÷ Account Value x Distribution Amount = Portion of the Withdrawal Treated as Contribution

Additional Considerations

In order to help maximize your education savings and avoid penalties and taxes, you will want to avoid overfunding a 529. We recommend considering splitting your savings between a 529 plan and a taxable account. Using this method, you benefit from the tax advantages of a 529 plan, as well as the flexibility of a taxable account. This will also allow you to take full advantage of the American Opportunity Tax Credit  or Lifetime Learning Credit if you are eligible. In order to claim these education credits, you must have education expenses that have not been paid for with 529 plan distributions.

Betterment offers a taxable education goal that can be used to save for education, either on its own or alongside your 529 education savings plan.


Giving the gift of education is important to many families. Some view a college degree as foundational to their loved one’s future success. With the cost of higher education increasing by about 5% per year, paying for a student’s education is an expensive prospect. 529 plans can be beneficial tools to help every dollar of your savings go even further. Through having disciplined savings habits, getting started early, and optimizing where to save your funds, you should be well on your way to reaching your goal.