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Jill A. Chafin
Jill A. Chafin is a staff writer at LendingTree. A seasoned pro in the field of savings and personal finance, her work has appeared on the Motley Fool’s Blueprint, How-to Geek’s Life Savvy and her own blog.
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Andrew Pentis
Andrew Pentis is a writer specializing in personal finance and paying for college. Andrew earned his degree from Arizona State University Walter Cronkite School of Journalism and Communication. His work has appeared in about 40 publications.
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Xiomara Martinez-White
Xiomara Martinez-White is a copy editor at LendingTree and its associated companies. A graduate of the CUNY Graduate School of Journalism, her previous experience includes roles at Bustle/BDG Media and the International Herald Tribune.
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Michael Kitchen
Michael Kitchen is a senior managing editor at LendingTree. A veteran news journalist, he has previously worked for MarketWatch, Dow Jones Newswires, Voice of America, Time Magazine, National Public Radio and others.
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Updated on:
December 4th, 2020
Content was accurate at the time of publication.
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If you’re saving for college, you might be familiar with 529 plans. A 529 college savings plan is a tax-advantaged account where you can save and invest money for future college tuition and qualified costs.
A 529 plan is usually the default strategy when saving money for college. But is it always your best choice? It’s important to evaluate your college savings options and explore alternatives to 529 plans before deciding which approach you’ll take to help pay for college when the time comes.
Specifically, let’s take a look at:
- Pros and cons of using a 529 plan
- Alternatives to 529 plans
The pros and cons of using a 529 plan
Benefits of using a 529 plan
There are a lot of great benefits to using a 529 plan to save for college. If you want to save your money in an account designed to help families create a financial plan to cover college costs, this option may be for you.
- Funds in a 529 plan are exempt from federal taxes if the funds are used for qualified educational expenses.
- Thanks to the Secure Act of 2019, qualified education expenses aren’t exclusive to college — you could employ the funds for private elementary, secondary or religious schools as well as apprenticeships, home schooling and even student loan debt repayment.
- 529 plans allow you to invest your savings, giving you the opportunity to earn a much better return on your money than if you were simply putting that cash in a savings account.
- Friends and family members can make gift contributions to your account for birthdays, holidays or any other given time.
- Unlike the traditional 529 plan, a 529 prepaid tuition plan allows you to lock in today’s tuition rates by paying upfront.
Drawbacks of using a 529 plan
Though there are many benefits to 529 plans, these plans also come with a few major disadvantages that just might push you toward 529 alternatives (see below).
- You have to use them for qualifying educational expenses to be able to reap any tax benefits.
- If the intended recipient of the savings doesn’t end up using the account, and you don’t have another child you could transfer them to, you’ll need to pay taxes and a 10% penalty fee on any earnings you take out and don’t use for qualified college expenses.
- 529 funds count toward that child’s assets and Expected Family Contribution (EFC) calculation for financial aid, potentially preventing a student from receiving need-based support in the form of grants, work-study programs and subsidized student loans.
- Investment options within the plans can be extremely limited and may come with high fees.
5 Alternatives to 529 plans
Given the downsides, it makes sense to consider alternatives to 529 plans as well. The good news is that these plans are not the only options for college savers. Some 529 alternatives include using a custodial account, Roth IRA or Coverdell Education Savings Account.
Here are five of the most common alternatives to 529 plans you can use for your own college savings plan:
- 1. Savings accounts
- 2. Roth IRAs
- 3. Brokerage accounts
- 4. Custodial accounts
- 5. Coverdell Education Savings Accounts
1. Savings accounts
Rather than turning to a 529 plan, you can always opt to save for your child’s college expenses through other, more flexible savings products such as a regular savings account or certificate of deposit (CD).
| Pros | Cons |
|---|---|
You're not bound to use them for the original purpose to reap tax benefits. Like some other 529 alternatives, if your child chooses not to go to college, there's nothing stopping you from using your funds for other purposes, whether that's helping them out with another venture or putting it toward your own financial goals. CDs offer some return on your investment, even if it's not much. | Traditional savings account interest is typically much lower than other account APRs. This might make it harder to reach your savings goal as quickly. You'll have easier access to your funds with a traditional savings account — beneficial if you have an emergency to tend to, but it could make it harder to stay on track with saving with such easy access to funds. |
2. Roth IRAs
Another 529 alternative to put away money for college and invest it for a potentially larger return is to utilize an account intended for retirement, such as a Roth IRA. Roth IRAs are individual retirement accounts that allow people to save and invest after-tax money.
| Pros | Cons |
|---|---|
You can withdraw any of your funds without penalty after age 59 1/2. You can also withdraw your contributions to your Roth IRA without penalty at any time. Paying for college expenses for you, a spouse, your children or grandchildren is a qualifying reason to withdraw your investment earnings early without penalty. Plus, if your child decides not to go to college, you can put the funds toward your retirement instead. | Roth IRAs have contribution limits. You can only contribute up to $6,000 per year to your Roth IRA if you're under the age of 50, and up to $7,000 if you're older. At the end of the day, Roth IRAs are designed for retirement. They come with some Roth IRA rules and regulations that are intended to help people save for retirement and to keep their money in their accounts until retirement. |
3. Brokerage accounts
Among alternatives to 529 plans, a brokerage account is a popular choice among more experienced investors. Brokerage accounts give you access to any investment that you’d like to buy or sell. These can range from stocks and mutual funds to bonds, currency and futures.
You can open a brokerage account through a broker. Options will vary depending on the company you choose to open an account with.
| Pros | Cons |
|---|---|
As with savings accounts, you can deposit and withdraw money in a brokerage account at any time without penalty. Some brokerage firms may offer you certain perks for opening an account with them, such as cash bonuses or a certain number of free trades. | There are no tax advantages of saving for college associated with brokerage accounts. You'll also be responsible for capital gains taxes if your money earns a return. You may be hit with brokerage account fees, such as management fees on the account itself. Additionally, depending on what you invest in, you may incur commission fees, too. You may be required to make a minimum investment to open a custodial account. This would mean needing to start saving before even beginning to put your funds in a designated account. |
4. Custodial accounts
If there’s a chance your child may not attend college, but you still want to plan for their future and support them financially, another 529 alternative is to utilize a custodial account. UGMA (Uniform Gift to Minors Act) and UTMA (Uniform Transfer to Minors Act) are two common options.
| Pros | Cons |
|---|---|
Both offer standard tax breaks for individuals under age 18. The first $1,100 is tax-free, the second $1,100 is taxed at your child's income tax rate and the remaining amount is taxed at the parent's income tax rate. There are no restrictions on how the funds are used so long as they benefit the child. This will keep your child from losing your financial assistance even if they opt not to attend college. | You have less control over how your child uses the money. Once your child reaches the age of majority, you can't legally prevent them from using the funds to take a vacation or buy a fancy car rather than for their education. |
5. Coverdell Education Savings Accounts (ESAs)
A Coverdell Education Savings Account, or ESA, is similar to a 529 plan in that it allows you to put away savings for your child’s education when they are under age 18. Like with 529 plans (again, as of 2019), qualified educational expenses aren’t limited to college expenses.
| Pros | Cons |
|---|---|
You can use funds for primary and secondary education expenses, including private school tuition. As with a 529 plan, it can be easier to ensure these savings remain designated for educational expenses. | Unlike other 529 alternatives, you can only contribute up to a total of $2,000 per year to these accounts (no matter how many accounts you open). If your modified adjusted gross income is higher than $110,000 (or $220,000 on a joint filed tax return), you can't establish one of these accounts. |
Evaluate alternatives to 529 plans as you save for college
There are a lot of college savings options. But personal finance is personal, and using a certain account to save for college may make sense depending on your specific situation.
If you decide to turn to alternatives to 529 plans, consider consulting with a financial advisor who can explain the pros and cons of any option you consider. Ultimately, your best bet is to avoid regular savings accounts and CDs because the interest rates are typically very low. With other 529 alternatives, however, you can put your money to work and potentially earn a return by investing your savings instead.
If you’re saving for a child’s education and have a time frame of five to 18 years before those funds are needed for college, investing in a 529 plan, Roth IRA or brokerage account can help you maximize the cash you set aside for those future expenses.
Whichever method you choose, be sure you take the time to fully understand how your decision will affect your full financial future in the long term. Save successfully, and your family may be able to avoid federal and private student loan borrowing.
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