529 accounts are one of the most popular options for college savings, but that doesn’t mean they’re your only choice. Many parents, family members, and friends use different accounts to contribute to a college savings account for their loved one.
Although 529 plans come with several advantages, there are also a number of benefits associated with certain alternatives. This article will cover everything you need to know about 529s and why they might not be the best way for you to save money for college.
Why Not Use a 529?
There’s nothing wrong with a 529 plan. However, it does come with certain restrictions that make it less desirable for some families. The most obvious issue is that funds deposited in a 529 need to go toward expenses related to college. If your child or loved one doesn’t attend a qualifying institution, you’ll pay ten percent in penalties.
These accounts are also more limited in terms of available investments. You might not be able to invest in the businesses you’re interested in. With that in mind, you may want to consider saving for college with one of these 529 alternatives.
ESAs
ESA accounts work similarly to 529s, enabling you to contribute money for education costs as your child grows up. Unlike with a 529, ESA funds don’t have to go toward college. You can also use them for expenses related to secondary or even primary school.
On the other hand, these accounts limit annual contributions to just $2,000. Plus, they’re only available to married couples filing jointly who make less than $220,000 and $110,000 for other filers. You should have a backup account in mind in case you have more than $2,000 to save for education in a given year.
Prepaid Tuition
Prepaid tuition plans are a recent development in college savings. They can help you save a lot of money by paying current tuition costs. Rather than saving money to eventually put toward tuition, these accounts give you tuition credits which you can redeem later (even if the price has changed).
Tuition costs are already high, but they’ve continued to increase even more over the last few years. By prepaying your tuition, you lock in current rates and protect yourself from potentially paying much more later on.
Keep in mind that prepaid tuition accounts, as the name implies, can usually only be used to fund tuition itself. You’ll need to make other arrangements if you also want to save money for other costs like housing and books.
The other concern with these accounts is that you may not live in an area where they’re supported. There are currently only eleven states offering prepaid tuition programs:
- Florida
- Illinois
- Maryland
- Massachusetts
- Michigan
- Mississippi
- Nevada
- Pennsylvania
- Texas
- Virginia
- Washington
If you live in one of these states, look into the details of your specific program and the benefits it offers. Many states exempt prepaid tuition benefits from both state and federal income taxes, giving you even more for your money. On the other hand, if you live in another area, you’ll need to look for another type of college savings account.
Roth IRAs
Roth IRAs are typically used to save for retirement, but they can be just as useful for funding college education. Unlike with a 529, you can withdraw money from a Roth IRA without having to pay penalties after the age of 59.5. You can withdraw your funds before that time, but you will have to pay taxes on any interest you earned.
If your child doesn’t end up attending college, you’ll still be able to take out money from your Roth IRA and use it for other things. On the other hand, this might not be the best option if your child would be going to college before you reached the minimum age for penalty-free withdrawals.
Also, keep in mind that any money you take out of your Roth IRA to pay for your child’s education is less money going toward your retirement.
An alternative is setting up a Roth IRA for your child. But of course your child would need earned income in order to contribute to their own Roth IRA.
Custodial Accounts
Custodial accounts are specifically designed for minors, yet you won’t pay any penalties on your funds if your child doesn’t go to college. They also offer lucrative tax breaks which can make them a more cost-effective choice than other college savings options.
While this isn’t necessarily a problem for every family, you should keep in mind that your child will have unrestricted access to the money once they reach 18. You’ll have more control over your funds if you use another type of account, so there’s a level of trust involved with a custodial account.
Savings Accounts
Conventional savings accounts such as the CIT Savings Builder are one of the most flexible options on this list. You can start saving today without committing to a specific purpose for the money. You’ll continue to earn interest each year and grow your investment in your child’s future.
That said, most savings accounts accrue interest at a significantly lower rate than other investment options. You might be able to do more with your money using an investment account or robo-advisor, than a savings account with more modest returns.
Of course, the upside of lower expected returns in a savings account is that your money is a bit “safer” in the short run vs. an investment account. Could you imagine if your child’s entire college fund was invested in the stock market, and he or she were entering college in the year 2008 when the stock market took a colossal tumble?
Brokerage Accounts
Brokerage accounts offer the flexibility of a savings account along with the potential gains associated with investments. You’ll be able to buy and sell anything from futures and bonds to mutual funds and stocks. Plus, you’re allowed to withdraw (and deposit) funds at any time without penalty.
Different firms offer different benefits and rates, so it’s important to find a firm you’re comfortable investing with. Shop around and compare offers to see which option gives you the best chance to reach your financial goals.
The main drawback of brokerage accounts is the fact that they don’t offer the tax savings available with certain other accounts. Some brokers also charge commissions and account fees which could impact your earnings.
529s Are Great, But You Have Other Options
529s are the most popular option for parents and family members interested in saving for college, but these alternatives offer numerous unique benefits you can’t get with a 529. No matter what account you decide to use, the most important thing is putting money in as soon as possible—even small contributions will add up to a lot by the time your child or loved one goes to college.
