College savings alternatives

[UNITED STATES] As the price of higher education continues to climb, American families are seeking creative ways to save for college. While 529 plans remain the most popular tax-advantaged vehicle for education savings, they are not the only option-and for some, not the best fit. Here’s a look at four leading alternatives to 529 plans, their advantages, and their drawbacks, helping families make informed decisions about their college savings strategies.

Exploring Alternatives: Why Look Beyond 529 Plans?

529 plans offer tax-free growth and withdrawals for qualified education expenses, but they come with notable limitations. Funds must be used for specific educational purposes or face penalties, investment choices may be restricted, and state-specific rules can complicate matters. For families seeking more flexibility, broader investment options, or different tax treatments, alternatives may provide a better match for their needs.

1. Coverdell Education Savings Accounts (ESA)

Overview:
Coverdell ESAs allow families to save up to $2,000 per year per beneficiary, with tax-free growth and withdrawals for qualified educational expenses-including K-12 costs, not just college.

Pros:

Broader investment choices, including individual stocks and mutual funds, compared to many 529 plans.

Funds can be used for a wide range of educational expenses, from elementary through higher education.

Tax-free growth and withdrawals for qualified expenses.

Cons:

Annual contribution limit is low ($2,000 per beneficiary).

Income restrictions apply: single filers must have a modified adjusted gross income (MAGI) below $110,000, and joint filers below $220,000.

No federal or state tax deductions for contributions.

Funds must be used by the time the beneficiary turns 30, or taxes and penalties may apply.

2. Roth Individual Retirement Accounts (IRA)

Overview:
Primarily a retirement savings tool, Roth IRAs can also be tapped for college expenses. Contributions (but not earnings) can be withdrawn tax- and penalty-free at any time, and earnings can be used for qualified education expenses without the typical early withdrawal penalty.

Pros:

Tax-free growth and withdrawals of contributions at any time.

Flexibility: if funds aren’t needed for education, they can remain invested for retirement.

No impact on financial aid eligibility in the same way as 529 plans.

Cons:

Annual contribution limits are lower than 529 plans ($7,000 in 2024 for those under 50).

Using Roth IRA funds for college may reduce retirement savings.

Earnings withdrawn for education expenses are subject to income tax, though not the 10% penalty if used for qualified education.

3. UGMA/UTMA Custodial Accounts

Overview:
Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) accounts allow adults to transfer assets to a minor, who takes control of the account at the age of majority (typically 18 or 21).

Pros:

Broad investment flexibility-funds can be invested in stocks, bonds, mutual funds, and more.

No restrictions on how the funds are used once the child reaches adulthood.

Some tax advantages: a portion of the account’s earnings may be taxed at the child’s lower rate.

Cons:

Assets become the child’s property at the age of majority, with no restrictions on usage.

Could significantly reduce financial aid eligibility, as assets are considered the student’s.

No specific tax advantages for education savings, and earnings may be subject to the “kiddie tax”.

4. Taxable Brokerage Accounts

Overview:
A standard investment account in the parent’s or child’s name, offering maximum flexibility in investment choices and fund usage.

Pros:

Unlimited investment options and no contribution limits.

Funds can be used for any purpose, not just education.

Potential for long-term capital gains tax treatment.

Cons:

No tax advantages for education savings-investment earnings are taxable.

If held in the child’s name, can negatively impact financial aid eligibility.

Market volatility can affect account value, posing a risk to savings.

Choosing the Right Alternative

Selecting the best college savings vehicle depends on a family’s financial goals, risk tolerance, income level, and the desired balance between flexibility and tax advantages. For those prioritizing tax benefits and education-specific savings, Coverdell ESAs or Roth IRAs may be suitable. Families seeking maximum flexibility may prefer UGMA/UTMA or brokerage accounts, but should be mindful of the impact on financial aid and lack of tax perks.

While 529 plans remain a strong choice for many, understanding the pros and cons of alternatives can help families craft a college savings strategy tailored to their unique circumstances. Consulting with a financial advisor is recommended to weigh the trade-offs and maximize both savings and financial aid eligibility.