The Benefits: Tax Treatment

  • All of the account's earnings are exempt from federal tax when they are withdrawn if they are used for qualified education expenses. This means that, unlike the taxes you have to pay on earnings from regular stock investments, you won't pay any tax on the 529 account earnings unless you end up using the money for something other than higher education. Earnings are currently tax-deferred in most states, as well.

  • A break on the earnings tax isn't the only tax advantage, either. Although your contributions aren't pre-tax (you pay state and federal tax on the money you put into the account), there are some states that let you deduct a portion of your contributions from your state taxes. More states will probably follow suit in the coming years.

Exemption
The current tax exemption on 529 account earnings became permanent in August, 2006 when President George W. Bush signed the Pension Protection Act of 2006 into law. Prior to the creation of this Act, the 529 tax exemption was set to expire in 2011 and revert to the original plan where the earnings were taxed at the child's rate.