If you are a parent looking to save for your child’s future, you must have heard about the 529 plan. Right from their inception, they have been one of the best vehicles available to save for college expenses. However, they do have their own downsides and given the rise of options available today, it may not be very wise to opt for the 529 plan. There’s a reason behind why I say this. In this article, I will explain to you why this long-existing savings option may not be the best choice and we will explore the best alternatives to the 529 plan.
What Is A 529 Plan And How Does It Work?
A 529 plan is a tax-advantaged savings account that can be utilised to save and pay for your child’s qualified college expenses. There are two types of 529 plans: prepaid tuition plans and college savings plans. Since the latter is more common, we will focus on that one.
A 529 plan enables you to make contributions, which grow tax-free. Even when your child starts withdrawing money from this account to pay for eligible expenses, there are no taxes on those distributions. In addition to these tax benefits, some states also offer additional tax deductions or credits to taxpayers who make contributions.
Although there are plenty of perks that come when saving for college with a 529 plan, you must know that there are some disadvantages that may cause you to look for better alternatives to the 529 plan.
Let’s quickly see what are the pros and cons of the 529 plan.
Pros:
- Funds in the 529 plan are exempt from federal taxes if used for eligible educational expenses.
- These educational expenses cover private elementary, secondary, or religious schools as well as apprenticeships, homeschooling, and even student loan debt repayment.
- Once you’ve contributed to a 529 plan, you can also invest the money. This helps you grow the money over time and get better returns on your sum.
- Friends and family members can also make contributions to this account on special occasions.
Cons:
- You have to use these funds only for qualifying educational expenses to be able to reap any tax benefits. That strictly includes tuition, fees, books, supplies, equipment, and in some cases, room and board.
- If you or your child uses the money for anything else, it’ll be subject to income taxes, in addition to a 10 percent penalty.
- If your child secures a scholarship, you can withdraw the money without incurring a penalty. However, the funds will still be subject to income taxes.
- You don’t get much control over where you invest your money — these investment options are determined by the state that offers the plan — and some states charge relatively high fees.
- Finally, 529 funds count towards your 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.
Here Are The Best Alternatives To The 529 Plan
After understanding so many downsides, it makes sense to consider better alternatives to the 529 plan for good college savings. Following is a list of such options.
1. Roth IRA
The first and foremost smart 529 plan alternatives to consider is the Roth IRA. It is an individual retirement account that allows you to save and invest after-tax money but it can also be used to save for college.
Pros
- You can withdraw your contributions at any time free of taxes and penalties.
- Withdrawals for qualified education expenses won’t incur a penalty.
- You can withdraw any of your funds without penalty after age 59 ½.
Cons
- The allowed annual contribution is limited. You can save only up to $6,000 in 2021, or up to $7,000 if you’re 50 or older.
- There are no state income tax benefits for Roth IRA contributions.
- Using a Roth IRA for college savings undercuts your efforts to save for retirement.
2. Brokerage Account
Among saving for college alternatives to the 529 plan, a brokerage account is quite a popular choice among more experienced investors. These accounts won’t give you any tax breaks, but they can give you more control over your investments. Options range from stocks and mutual funds to bonds and currency.
Pros
- A brokerage account gives you more power over investment choices.
- There are no limitations or penalties based on how you use the funds.
Cons
- There are no tax benefits.
- You have no incentive to hold onto the money for college expenses.
3. Custodial Accounts (UGMA/UTMA)
If there’s even a slight chance that your child may not attend college, but you still want to plan and save for their future, some good alternatives to the 529 plan that can still accelerate college in this situation are to utilize a custodial account. UGMA (Uniform Gift to Minors Act) and UTMA (Uniform Transfer to Minors Act) are two common options.
Pros
- Both offer standard tax breaks for students 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 aren’t any 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.
Cons
- 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 posh car rather than for their education.
These are the 3 good alternatives to the 529 plan. Hope you found this blog useful. Happy saving!
Thank you for reading this blog on the 529 Plan Alternatives.
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