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How does a 529 savings plan work?

The 529 savings plans were created by a federal law but are administered by the states. Parents create and put money into a 529 account, which is then invested in stocks and bonds, more like a 403(b) or a 401(k) than a bank savings account. They can select their level of risk: perhaps choosing a plan that invests in higher-risk options with higher rates of return for a child in first grade, then switching to safer options such as bonds as a child gets closer to college.

While the initial investment is taxed normally—through payroll taxes—the federal government doesn’t tax the growth parents see on their 529 funds (unlike bank interest or other investments, which count as income and are taxed). Before the new tax law, the saved 529 money could be used only for qualified higher education expenses such as college tuition, room and board, and books.

How did the new law change things?

Expanding to cover K–12 education was a natural, logical step. The tax plan says that the federal government will extend this benefit—not taxing the growth of the saved money—down to the primary and secondary level. So parents can begin saving as soon as a child is born, and can now use the money for elementary and high school expenses in addition to college costs. However, some state laws may not automatically follow the new federal expansion to K–12. Some states may decide to limit their benefits to college expenses only.

If I pay tuition at a Christian school, how can I take advantage of this?

1. Check with your state 529 plan or tax department to make sure the state follows the federal law to include K–12 tuition as a qualified expense. Most state legislatures meet in January, so we anticipate these decisions could be made in the first quarter of the year.

2. Set up a 529 plan. You can find out how by visiting the webpage for your state’s 529 plan. Often you can open an account through the site, though in some states you can use a broker or a bank. They are willing to help you; they want to make it easy for you to do.

3. A 529 plan is designed as a savings plan, and the growth over time is where you’ll save on federal taxes. If you aren’t going to keep a balance, and your state does not offer other benefits, opening this account may not be fruitful. It may come down to whether you’re ready to risk your savings through investments or choose the safety of a regular bank savings account.

4. Currently, 529 plans can make payments directly to colleges when it comes time to pay tuition. Check with your 529 plan administrator to see if that’s possible for primary and secondary schools. If not, you can request the money be sent directly to you, and can then use it to pay tuition. (Keep your receipts!)