15 Myths About 529 Plans That Stop Parents (and Grandparents) From Using Them Right
529 plans are way more flexible than people realize, and if you know the rules, there are smart ways to use those funds without getting hit with penalties.
Considering that as of June 2024, there were 16.8 million 529 plan accounts in the U.S., holding a total of $508 billion in savings, it’s clear this isn’t some niche topic.
The average account balance was $30,295, according to the Education Data Initiative. That’s a lot of money sitting in accounts people don’t fully understand.
This article is here to clear things up. We’ll break down the biggest myths about 529 plans like what happens if your kid gets a scholarship, what counts as a qualified expense, and why your money isn’t as “locked up” as you think.
Think you’ve got it all figured out? Keep reading, I bet you’ll learn something new.
Table of Contents
What Is a 529 Plan and Why It Matters
A 529 plan is one of the most powerful tools for saving for education. These tax-advantaged accounts let parents and grandparents grow money tax-free and withdraw it for qualified expenses like tuition, books, and even K-12 schooling.
Recent rule changes have made them even more flexible, allowing for things like student loan repayments and Roth IRA rollovers.
But despite how useful 529 plans are, many families just don’t understand them. Too many people believe the money is locked up, that scholarships make savings useless, or that contributions must be made in small, annual amounts. These myths lead to missed opportunities and unnecessary worry.
Let’s clear things up by breaking down the most common misconceptions about 529 plans—and what the truth really is.
Myth #1: If Your Child Gets a Scholarship, You Lose Your 529 Savings
One of the biggest misconceptions about 529 plans is that if your child gets a scholarship, your money is stuck and wasted. Not true. You can withdraw an amount equal to the scholarship without paying the 10% penalty that normally applies to non-qualified withdrawals.
Yes, you’ll owe income tax on the earnings portion, but the money you contributed comes out tax- and penalty-free. This rule exists because the government isn’t trying to punish you for your kid’s success, it’s actually built into the plan to give you flexibility.
You can use that withdrawn money for other expenses, save it for grad school, or even roll it over into a Roth IRA if you meet the conditions. A scholarship doesn’t trap your money, it just gives you more ways to use it wisely.
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Myth #2: If You Take Money Out for Non-Educational Expenses, You Face a Massive Penalty
It’s true that if you take money out of a 529 for non-educational expenses, you’ll typically owe income tax on the earnings plus a 10% penalty. But this isn’t some financial death sentence.
There are exceptions where that penalty is waived, like if your child gets a scholarship, attends a U.S. military academy, becomes disabled, or, unfortunately, passes away. In those cases, you’d still pay income tax on the earnings, but no penalty.
Plus, the penalty only applies to the earnings, not the original contributions, you already paid taxes on that money when you earned it. So while it’s not ideal to take non-qualified distributions, it’s not nearly as devastating as people make it out to be.
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Myth #3: You Can Wait Years to Withdraw Scholarship-Equivalent Funds
If your child earns a scholarship, you can absolutely take a penalty-free withdrawal for that amount, but timing is everything. The withdrawal needs to happen in the same calendar year the scholarship was received.
This is because the IRS wants to see a clear link between the scholarship and the distribution for tax reporting purposes. If you wait too long, that link gets murky, and you could lose the penalty-free benefit.
It’s not about rushing to cash out your 529, it’s about staying organized and making sure your tax paperwork matches up. Treat it like an expiration date, you don’t want to miss it.
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Myth #4: 529 Plans Only Cover Tuition and Fees
If you think 529 plans are just for tuition and fees, you’re missing out on their full potential. Qualified education expenses include much more, like books, laptops, software, and even internet access, because let’s face it, no one’s surviving college without Wi-Fi.
If your student is enrolled at least half-time, room and board expenses also qualify, which is a huge help. Got a student with special needs? Equipment related to their education is covered, too.
Plus, you can use up to $10,000 per year for K-12 tuition and up to $10,000 lifetime for student loan repayments. It’s not just a tuition fund, it’s an education fund with a wide range of uses.
Myth #5: You Must Spend 529 Funds on the Named Beneficiary
A lot of people think once you name a beneficiary on a 529 plan, that money is tied to them forever. That’s simply not the case. You can change the beneficiary to another family member, including siblings, cousins, or even yourself if you decide to go back to school.
And with recent rule changes, you can roll over up to $35,000 (lifetime limit) into a Roth IRA for the beneficiary, giving those funds new life as retirement savings. If your child doesn’t need all the money, maybe because of scholarships or they didn’t pursue college, you’ve got options.
The plan is designed to be flexible, so your money doesn’t go to waste.
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Myth #6: 529 Withdrawals Are Always Taxed
This myth is flat-out wrong. Qualified withdrawals, meaning money used for approved educational expenses, are completely tax-free on both the federal and, in most cases, state level.
The confusion comes from non-qualified withdrawals, which are subject to income tax on the earnings plus a 10% penalty. But even then, your original contributions aren’t taxed because you already paid taxes on that money before putting it into the account.
Plus, with exceptions like scholarships, military service, or disability, the penalty can be waived. The key takeaway? As long as you’re using the funds for qualified expenses, you won’t owe a dime in taxes.
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Myth #7: Only Parents Can Withdraw the Money
A lot of people assume that only the parent or account holder can touch the funds in a 529 plan, but that’s not the case. While the account owner controls the money, they can request the distribution be made directly to themselves, the student, or even the educational institution.
This flexibility comes with some tax advantages too. If the distribution is sent to the student, the 1099-Q tax form will be issued in their name, and since students usually fall into a lower tax bracket, this can reduce the tax hit on non-qualified withdrawals.
It’s all about who you choose to receive the funds and how that decision aligns with your tax strategy. Control stays with the account owner, but the payout can be directed based on what makes the most sense financially.
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Myth #8: Unused 529 Money Must Be Cashed Out with Penalties
People often think that if their child doesn’t use all the money in a 529, they’re stuck either spending it on unneeded education expenses or facing penalties to cash it out. That’s not true. You have plenty of options for leftover funds.
You can keep the account open for graduate school, shift the money to another family member, siblings, cousins, even yourself, or, thanks to new rules, roll over up to $35,000 into a Roth IRA for the beneficiary.
There’s no deadline forcing you to drain the account, so the money can sit, grow, and be used later when the timing is right. A 529 isn’t a “use it or lose it” deal, it’s more like a flexible savings tool with room to adapt as life changes.
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Myth #9: 529 Plans Have No State-Specific Rules
Many people overlook the fact that while 529 plans are federally tax-advantaged, states have their own rules that can affect your money. For example, California imposes an extra 2.5% state tax penalty on earnings from non-qualified withdrawals, on top of federal penalties.
Some states also offer tax deductions or credits for contributions, but if you take non-qualified distributions, they might recapture those benefits, meaning you’ll have to pay back some of the tax savings you initially received.
The key here is to understand your state’s specific tax laws because they can have a big impact, especially if you move. What’s true for one state might not apply in another, and that can either save you money or cost you if you’re not paying attention.
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Myth #10: 529 Plans Are a “Use It or Lose It” Investment
This myth probably causes more stress than it should. People think if their child doesn’t go to college, the money is wasted. Not even close. 529 plans are designed with flexibility in mind.
If college isn’t in the cards, you can transfer the funds to another beneficiary, save them for future education needs like grad school, or roll over up to $35,000 into a Roth IRA if the criteria are met.
There’s no ticking clock forcing you to drain the account, and no rule saying the original beneficiary is the only one who can benefit. Your money isn’t trapped, it’s just waiting for the next opportunity.
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Myth #11: 529 Plans Are Only for College
The term “college savings plan” really undersells what a 529 can do. While it’s great for college, it also covers a lot more. You can use up to $10,000 per year for K-12 tuition at private or religious schools, and it’s not limited to traditional four-year universities.
Trade schools, vocational programs, and even registered apprenticeship programs qualify. On top of that, you can apply up to $10,000 (lifetime) toward student loan payments, which is a game-changer for recent grads.
The point is, 529 plans aren’t just about college, they’re about funding education in whatever form it takes.
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Myth #12: 529 Plans Are Risky Investments
Some people shy away from 529 plans because they think the money is tied up in risky investments. The truth? You control how the funds are invested.
Most plans offer age-based portfolios that automatically adjust over time, shifting to more conservative investments as the beneficiary gets closer to college age. If you prefer more control, you can choose static options based on your risk tolerance.
Plus, the tax advantages alone, tax-free growth and tax-free withdrawals for qualified expenses, help boost your returns over time. Like any investment, there’s some risk, but it’s not the wild gamble people make it out to be.
It’s a smart, flexible tool designed to grow with your goals.
Myth #13: Only Parents Can Contribute to a 529 Plan
One of the biggest misconceptions about 529 plans is that only parents can contribute. In reality, anyone, such as grandparents, aunts, uncles, family friends can add money to the account. This makes 529 plans a powerful tool for intergenerational wealth building.
Grandparents, in particular, often use 529 plans as a tax-efficient way to help fund their grandchildren’s education. Some states even offer tax deductions or credits for contributions, which can make gifting even more attractive.
Even better, recent rule changes prevent grandparent-owned 529 plans from negatively impacting financial aid eligibility, removing a major concern that previously discouraged their use.
Myth #14: You Can Only Contribute Annually
Some people think 529 plans require small, yearly contributions, but that’s not the case. You can contribute in lump sums, making them a great option for windfalls, bonuses, or gifts.
There’s even a special tax advantage for lump-sum contributions: the five-year gift tax averaging rule. This allows you to contribute up to five years’ worth of the annual gift tax exclusion ($18,000 per person in 2024) at once—meaning an individual can contribute up to $90,000 in a single year without triggering gift taxes. A married couple could contribute $180,000 for a child or grandchild in one go.
This makes 529 plans a powerful estate planning tool. Instead of gifting cash directly, which could have tax implications, wealthy individuals can use 529s to reduce their taxable estate while funding education.
Myth #15: I Make Too Much Money to Benefit from a 529 Plan
Some people assume that 529 plans are only for middle- or lower-income families and that high earners won’t see any tax advantages. That’s simply not true.
Unlike Roth IRAs or other tax-advantaged accounts, 529 plans have no income limits. Anyone can contribute and benefit from tax-free growth and withdrawals for qualified expenses.
The federal tax benefits still apply even if your state doesn’t offer a tax deduction or credit for contributions. Earnings in the account grow tax-free, and as long as the money is used for education, withdrawals won’t trigger federal taxes either.
For high earners looking for additional ways to fund education while minimizing taxes, a 529 plan can be a powerful tool—without the income restrictions that limit other savings vehicles.
The Bottom Line on 529 Plans
529 plans aren’t the rigid, restrictive accounts people think they are. Between penalty-free scholarship withdrawals, flexible beneficiary options, and even Roth IRA rollovers, these plans offer way more freedom than most realize.
Your money isn’t locked up, it’s working for you with tax advantages that can stretch across generations. The key is knowing the rules so you can use them to your advantage instead of leaving money on the table.
Don’t let myths scare you into bad decisions. A 529 plan is a powerful tool when you actually understand how flexible it really is.
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