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Does a 529 Plan Earn Interest?


A 529 plan, a popular choice for college savings, typically does not directly earn interest in the traditional sense. Instead, the growth of a 529 plan depends on the investment options chosen within the plan, such as mutual funds, which can appreciate over time. While the plan itself doesn’t accrue interest like a savings account, the investments within the plan can grow tax-deferred, providing potential for substantial long-term gains.

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What Is a 529 Plan?

A 529 plan is a tax-advantaged account designed to encourage saving for future education costs. Named after Section 529 of the Internal Revenue Code, these plans offer significant tax benefits. Contributions are made with after-tax dollars, but the earnings grow tax-deferred. Withdrawals are also tax-free when used for qualified education expenses, which include tuition, fees, books, and room and board, among others. This makes 529 plans an attractive option for parents and guardians looking to fund their children’s education.

While a 529 plan’s investment growth is not subject to federal taxes, many states also offer tax deductions or credits for contributions to their state’s 529 plans. This tax treatment can result in substantial savings compared to taxable investment accounts.

529 plans are popular because they provide an effective way to save for education costs. You can, for example, use a 529 plan to pay for student loans, with a lifetime limit of $10,000 per beneficiary. And, you can also use the plan to pay up to $10,000 per year in tuition expenses for K-12 grades at public, private, or religious schools.

529 plans also offer high contribution limits, which can be advantageous for those who want to invest large sums of money over time. Though many people stick with the annual gift tax exclusion ($18,000 in 2024). Additionally, account holders retain control of the funds and can change the beneficiary to another eligible family member if the original beneficiary decides not to pursue higher education.

Types of 529 Plans

A 529 plan is a tax-advantaged investment vehicle used to save for qualified education expenses.

Keep in mind that there are generally two types of 529 plans and distinguishing between them is key.

College savings plans function similarly to retirement investment accounts, like 401(k)s or IRAs. Contributions are invested in mutual funds, ETFs or similar investment vehicles. The value of the account can increase or decrease based on the performance of the investments chosen by the account holder.

Prepaid tuition plans, on the other hand, allow participants to purchase credits at today’s rates to be used in the future. They are typically restricted to specific colleges or university systems and may not cover all educational expenses.

How 529 Plans Earn Interest

The way a 529 plan earns interest depends on the investment options chosen by the account holder.

When you open a 529 plan, you can select from a range of investment options, including mutual funds, exchange-traded funds (ETFs) and age-based portfolios. Mutual funds and ETFs invest in a diversified mix of stocks, bonds, and other securities. The performance of these investments determines the growth of your 529 plan. For instance, if the mutual fund’s underlying assets perform well, the value of your 529 plan will increase, effectively earning interest.

Age-based portfolios are a popular choice for many 529 plan holders. These portfolios automatically adjust the allocation of assets based on the beneficiary’s age. Typically, they start with a higher allocation in stocks when the beneficiary is younger, aiming for higher growth potential. As the beneficiary approaches college age, the portfolio shifts towards more conservative investments like bonds and money market funds to reduce risk. This strategic allocation helps to maximize growth while protecting the accumulated savings as the time to use the funds approaches.

While most 529 plans are considered investment accounts, some offer FDIC-insured savings account options or certificates of deposit (CDs) for those who prefer a guaranteed rate of return. These options provide a fixed interest rate, which can allow your contributions to grow steadily over time without the risk associated with market fluctuations.

Maximizing 529 Plan Returns

Starting early and contributing often can help maximize the returns of a 529 plan.

Maximizing the returns of a 529 plan involves strategic planning and informed decisions. Here are key steps to help you achieve this:

  • Start early: The sooner you begin contributing, the more time your investments have to grow. Compounding interest can significantly boost your returns over time.
  • Regular contributions: Consistent contributions, even small ones, can add up. Automate deposits to maintain steady growth.
  • Choose the right plan: Different states offer various 529 plans with unique benefits and investment options. Compare plans to find the one that best suits your needs.
  • Invest in low-cost funds: Opt for investment options with low fees. High fees can erode your returns over time, so selecting low-cost index funds or ETFs can help maximize growth.
  • Age-based investment options: Consider age-based portfolios that automatically adjust the asset allocation as the beneficiary gets closer to college age, reducing risk as the time to use the funds approaches.
  • Monitor and adjust: Regularly review your investments’ performance and make adjustments as needed to stay aligned with your goals.

How to Open a 529 Plan

Opening a 529 plan is a relatively straightforward process. Here are seven general steps to effectively open and manage one:

  1. Research plans: Begin by researching the different 529 plans available. Each state offers its own plan, and some states provide tax benefits for residents.
  2. Choose a plan: Select a plan that aligns with your savings goals, considering factors like fees, investment options, and state tax benefits.
  3. Open an account: Visit the website of your chosen 529 plan. Most plans allow you to open an account online.
  4. Fund the account: Decide how much to contribute initially. Many plans have low minimum contributions to get started.
  5. Set up automatic contributions: Consider setting up automatic contributions to make regular saving easier.
  6. Choose investments: Select from the investment options offered by the plan.
  7. Monitor and adjust: Regularly review your account and adjust contributions or investments as needed.

Bottom Line

While 529 plans don’t typically earn interest in the traditional sense, they offer significant growth potential through a variety of investment options. These plans provide a tax-advantaged way to save for future education costs, making them an attractive option for many families.

Education Planning Tips

  • While 529 plans are subject to the annual gift tax exclusion limit, families can choose to make five years’ worth of contributions at once. This approach, known as “superfunding,” accelerates the potential compound interest that the account can generate, leading to bigger balances. However, J.P. Morgan found that superfunding can result in leftover funds, which may be treated as taxable income if you don’t have another beneficiary in the same generation to transfer it to.
  • A financial advisor can help you plan and save for your children’s education needs. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

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