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Key takeaways

  • 529 savings plans can cover qualified educational expenses at all levels, including graduate school.
  • The money you contribute to a 529 plan is federally tax-deferred, and eligible withdrawals from these accounts are tax-free.
  • Money from a 529 plan can be used for both traditional and online degree programs, as long as they are offered by an accredited institution.

A 529 savings plan is designed to make it easier to save for higher education at every level, from undergraduate school to a graduate program and beyond. As long as your institution and expenses are eligible, you can enjoy the tax benefits of a 529 plan while also reducing your reliance on student loans for graduate school.

What is a 529 savings plan?

A 529 plan is a tax-advantaged education savings plan. Originally, these accounts were designed to cover only postsecondary education costs, but now you can also use them for K-12 education and apprenticeship programs. You can also use a 529 plan for graduate school.

The money you contribute to a 529 plan is federally tax-deferred, meaning your earnings can grow without the burden of taxes. Eligible withdrawals from this kind of account are also tax-free.

Additionally, many states offer a tax deduction or credit for those who contribute to a 529 plan, making it even more attractive for parents who want to save for their children’s education. For example, Indiana offers a 20 percent tax credit (up to $1,000) for contributions made to a 529 savings plan within a calendar year.

That said, strict requirements exist to maintain the tax-free status of your contributions and withdrawals.

Using your 529 savings plan for graduate school

While many parents use a 529 savings plan to cover a student’s undergraduate education, 529 plans can also be used to help pay for a graduate degree. If you’re considering using a 529 plan for graduate school, here are some things to remember.

Eligible financial institutions

To use your 529 savings plan funds for your graduate studies, you must attend an eligible educational institution. In general, that includes any college, university, vocational school or other postsecondary institution eligible to participate in the U.S. Department of Education’s student aid program.

This includes most graduate and professional schools in the U.S. and some foreign educational institutions. So whether you’re going to medical school, dental school or business school, the chances are high that you’ll be able to use your 529 plan funds.

Your school should be eligible if it’s on the Department of Education’s database of accredited postsecondary institutions and programs.

Expenses covered

A 529 savings plan can be used to pay for qualified education expenses. According to the IRS, that includes tuition, fees and other related expenses incurred by:

  • You or your spouse if you file a joint tax return.
  • A student you claim as a dependent.
  • A third party, including relatives and friends, named as the plan’s beneficiary.

Beyond tuition and fees paid directly to an accredited institution, other expenses can include:

  • Books.
  • Supplies.
  • Equipment.
  • Room and board (if you’re enrolled on at least a half-time basis).
  • Computer-related expenses.
  • Special needs expenses.

Note that this list applies to 529 savings plans but not necessarily to 529 prepaid tuition plans, which are different types of accounts with more limited uses.

If you withdraw money for ineligible expenses, the earnings portion of the withdrawal will be taxed as ordinary income, and you’ll be subject to a 10 percent penalty. You won’t pay the tax or penalty on your account contributions because the government has already taxed that money. You will be responsible for paying taxes on any investment earnings earned on the account.

If this applies to you, your account servicer should issue a 1099-Q form for tax-filing purposes.

  • One exception to this rule: If the student receives a scholarship, they or their parents can withdraw up to the scholarship amount and use that money without penalty. You will, however, need to pay income taxes on the portion of the withdrawal attributed to investment gains.

Can a 529 plan be used for online degree programs?

If you’re interested in pursuing an online graduate degree, you’ll be happy to know that 529 savings plans can also be used for that. Online degree programs offer more flexibility, and you may find the schedule easier to work with than attending in-person classes. In some cases, online courses can be more cost-effective than in-person ones, allowing you to stretch the funds in your 529 plan even further. However, for your 529 plan to cover your online courses, you’ll need to be enrolled in an accredited program at an eligible school.

What are the drawbacks of using a 529 plan for graduate school?

One downside of a 529 savings plan is that it’s an investment, which means there’s volatility. If you invest the money in a 529 plan in stocks or mutual funds so your savings can grow over time, you face the potential of losing money in your account in the near term.

Considering this risk is especially important if you’re saving for graduate school at the last minute. After all, investments are never guaranteed to show a positive return, but that’s especially true over timelines of a few years or less. If you’re putting money into a 529 plan that you may need soon, the possibility of seeing your account balance drop should be on your radar.

Money in a 529 plan can impact your eligibility for financial aid, and 529 funds in your name have a greater impact on aid eligibility than those held by a parent for their child. All 529 assets must be claimed on the Federal Application for Federal Student Aid form (FAFSA), which will impact eligibility for loans, grants, and other funding.

What are the consequences of using a 529 plan for non-qualified education expenses?

Non-qualified distributions from a 529 plan occur when the money is used for expenses other than those qualified as education expenses like tuition, fees, room and board and necessary course materials.

If you use the money for non-qualified expenses, you will be required to pay federal and state income taxes (where applicable) and a 10 percent penalty on the earnings portion of the account. The best way to avoid this is to carefully review what your school deems a qualified education expense. You can check this by visiting your school’s financial aid portal or by talking to one of the school’s financial aid advisors.

Who should use a 529 plan for graduate school?

The main benefit of 529 savings plans is that money can grow tax-free, and distributions are tax-free when used to cover eligible higher education expenses.

If you live in a state that offers tax benefits for contributions made to a 529 savings plan, using one can help lower your tax burden while making it easier to cover college expenses.

In general, 529 plans for graduate school make the most sense if:

  • You’re a high earner looking for ways to maximize tax advantages.
  • You have money left over in a 529 plan after paying for undergraduate education.
  • You started saving early.

The bottom line

Using a 529 savings plan for graduate school can make it easier to afford your degree and reduce the student loans you need. Before you invest in one of these accounts, it’s important to understand both the drawbacks and benefits of 529 plans, how to maximize their value and how to avoid penalties.

You may also want to consider other education savings plans, such as a Coverdell education savings account or a Roth IRA. As you shop around and compare your options, being well-informed will put you in a position to pick the best one for you.