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 to saving money for college. But is it always the 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:
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. You can also make the most of this saved money because funds in a 529 plan are exempt from federal taxes if the funds are used for qualified educational expenses.
Another upside of 529 plans is that they 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. Another big plus is that friends and family members are able to make gift contributions to your account for birthdays, holidays or any other given time.
What’s wrong with a 529 plan?
Though there are many benefits to 529 plans, these plans also come with a few major disadvantages.
For starters, one of the biggest downsides is that 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 attending college, 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.
Additionally, unlike with other savings vehicles, a 529 plan must be used strictly for college expenses. You can’t use them for private secondary school tuition, for example. Plus, 529 funds count toward that child’s assets and Expected Family Contribution (EFC) calculation for financial aid. Depending on where you live, this could prevent students from receiving need-based aid.
Another drawback of 529 plans is that the investment options within the plans can be extremely limited and may come with high fees. Without a professional who can help guide you, understanding the right financial moves to make can be tricky, and mistakes can cost you money.
With the downsides of 529 plans, it makes sense to consider other college savings options as well. The good news is that these plans are not the only options for college savers. Some examples 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
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).
- You’re not bound to using them for the original purpose to reap tax benefits. Unlike with 529 plans, 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 it it’s not much.
- Traditional savings accounts typically earn much lower Interest rates. 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 option 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.
- 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
Another alternative option is to utilize a simple brokerage account to save for college. 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.
- 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 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 option is to utilize a custodial account. UGMA (Uniform Gift to Minors Act) and UTMA (Uniform Transfer to Minors Act) are two common options.
- Both offer standard tax breaks for individuals under age 18. The first $1,000 is tax-free, the second $1,000 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. The key difference is that with this account, qualified educational expenses aren’t limited to college expenses.
- 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.
- You can only contribute up to $2,000 per year to these accounts.
- 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.
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 usually very low. 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 timeframe 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.
Emilia Benton contributed to this report.
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1 Important Disclosures for Splash Financial.
Splash Financial Disclosures
Terms and Conditions apply. Splash reserves the right to modify or discontinue products and benefits at any time without notice. Rates and terms are also subject to change at any time without notice. Offers are subject to credit approval. To qualify, a borrower must be a U.S. citizen or permanent resident in an eligible state and meet applicable underwriting requirements. Not all borrowers receive the lowest rate. Lowest rates are reserved for the highest qualified borrowers. If approved, your actual rate will be within a range of rates and will depend on a variety of factors, including term of loan, a responsible financial history, income and other factors. Refinancing or consolidating private and federal student loans may not be the right decision for everyone. Federal loans carry special benefits not available for loans made through Splash Financial, for example, public service loan forgiveness and economic hardship programs, fee waivers and rebates on the principal, which may not be accessible to you after you refinance. The rates displayed may include a 0.25% autopay discount.
The information you provide to us is an inquiry to determine whether we or our lenders can make a loan offer that meets your needs. If we or any of our lending partners has an available loan offer for you, you will be invited to submit a loan application to the lender for its review. We do not guarantee that you will receive any loan offers or that your loan application will be approved. Offers are subject to credit approval and are available only to U.S. citizens or permanent residents who meet applicable underwriting requirements. Not all borrowers will receive the lowest rates, which are available to the most qualified borrowers. Participating lenders, rates and terms are subject to change at any time without notice.
To check the rates and terms you qualify for, Splash Financial conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, the lender will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.
Splash Financial and our lending partners reserve the right to modify or discontinue products and benefits at any time without notice. To qualify, a borrower must be a U.S. citizen and meet our lending partner’s underwriting requirements. Lowest rates are reserved for the highest qualified borrowers. This information is current as of October 1, 2020.
2 Important Disclosures for Laurel Road.
Laurel Road Disclosures
All credit products are subject to credit approval.
Laurel Road began originating student loans in 2013 and has since helped thousands of professionals with undergraduate and postgraduate degrees consolidate and refinance more than $4 billion in federal and private school loans. Laurel Road also offers a suite of online graduate school loan products and personal loans that help simplify lending through customized technology and personalized service. In April 2019, Laurel Road was acquired by KeyBank, one of the nation’s largest bank-based financial services companies. Laurel Road is a brand of KeyBank National Association offering online lending products in all 50 U.S. states, Washington, D.C., and Puerto Rico. All loans are provided by KeyBank National Association, a nationally chartered bank. Member FDIC. For more information, visit www.laurelroad.com.
As used throughout these Terms & Conditions, the term “Lender” refers to KeyBank National Association and its affiliates, agents, guaranty insurers, investors, assigns, and successors in interest.
Assumptions: Repayment examples above assume a loan amount of $10,000 with repayment beginning immediately following disbursement. Repayment examples do not include the 0.25% AutoPay Discount.
Annual Percentage Rate (“APR”): This term represents the actual cost of financing to the borrower over the life of the loan expressed as a yearly rate.
Interest Rate: A simple annual rate that is applied to an unpaid balance.
Variable Rates: The current index for variable rate loans is derived from the one-month London Interbank Offered Rate (“LIBOR”) and changes in the LIBOR index may cause your monthly payment to increase. Borrowers who take out a term of 5, 7, or 10 years will have a maximum interest rate of 9%, those who take out a 15 or 20-year variable loan will have a maximum interest rate of 10%.
KEYBANK NATIONAL ASSOCIATION RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE.
This information is current as of September 9, 2020. Information and rates are subject to change without notice.
3 Important Disclosures for SoFi.
4 Important Disclosures for Earnest.
To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants will qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest fixed rate loan rates range from 2.98% APR (with Auto Pay) to 5.49% APR (with Auto Pay). Variable rate loan rates range from 1.99% APR (with Auto Pay) to 5.34% APR (with Auto Pay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms 10 years or less. For loan terms of 10 years to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 1.82% and 5.50% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of October 26, 2020, and are subject to change based on market conditions and borrower eligibility.
Auto Pay discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 10/26/2020. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice. Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 302 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, email us at [email protected], or call 888-601-2801 for more information on our student loan refinance product.
© 2020 Earnest LLC. All rights reserved. Earnest LLC and its subsidiaries, including Earnest Operations LLC, are not sponsored by or agencies of the United States of America.
5 Important Disclosures for LendKey.
Refinancing via LendKey.com is only available for applicants with qualified private education loans from an eligible institution. Loans that were used for exam preparation classes, including, but not limited to, loans for LSAT, MCAT, GMAT, and GRE preparation, are not eligible for refinancing with a lender via LendKey.com. If you currently have any of these exam preparation loans, you should not include them in an application to refinance your student loans on this website. Applicants must be either U.S. citizens or Permanent Residents in an eligible state to qualify for a loan. Certain membership requirements (including the opening of a share account and any applicable association fees in connection with membership) may apply in the event that an applicant wishes to accept a loan offer from a credit union lender. Lenders participating on LendKey.com reserve the right to modify or discontinue the products, terms, and benefits offered on this website at any time without notice. LendKey Technologies, Inc. is not affiliated with, nor does it endorse, any educational institution.
Subject to floor rate and may require the automatic payments be made from a checking or savings account with the lender. The rate reduction will be removed and the rate will be increased by 0.25% upon any cancellation or failed collection attempt of the automatic payment and will be suspended during any period of deferment or forbearance. As a result, during the forbearance or suspension period, and/or if the automatic payment is canceled, any increase will take the form of higher payments. The lowest advertised variable APR is only available for loan terms of 5 years and is reserved for applicants with FICO scores of at least 810.
As of 11/13/2020 student loan refinancing rates range from 1.97% to 8.54% Variable APR with AutoPay and 2.95% to 8.77% Fixed APR with AutoPay.