Planning for your child’s college education can feel overwhelming—but it doesn’t have to be! With tuition costs climbing every year, and limited access to financial aid, having a solid savings plan to help prepare you for your child’s education costs can provide financial peace of mind, reduce future debt burdens, and give your family the flexibility to focus on what truly matters. For busy couples in their 30s and 40s balancing careers, kids, and newfound wealth, having the right strategy can make all the difference. Even for grandparents wanting to contribute to their grandchild’s future, having an effective plan is important.
Here’s a breakdown of four top college savings options—in plain English—to help you prepare for your child’s future.
The Top 4 College Savings Accounts and Plans
1. 529 College Savings Plans
A 529 College Savings Plan can be a great go-to college savings tool. Why? Because it’s packed with perks like:
- Tax Benefits: Your money is subject to tax-deferred growth (your money is not taxed as it grows), and tax-free withdrawals for qualified expenses—like tuition, fees, or books—at the federal level. Depending on the state you currently reside in, you may be eligible for a state tax deduction!
- Flexibility: It’s not just for college! You can use it for K-12 tuition (up to $10,000 per year), at a public, private, secondary public, or religious school, certain apprenticeship programs, and more.
- Big Contribution Limits: Depending on the state, you can save over $300,000 per beneficiary—way more than other savings accounts allow.
- State-Specific Perks: In California, the ScholarShare 529 plan offers low fees and excellent investment options.
The best part? If your child doesn’t use all the funds, you can transfer them to another family member. Keep in mind, however, that non-education withdrawals will trigger taxes and a 10% penalty on earnings.
Even better, starting in 2024, you can roll unused 529 plan assets—up to a lifetime limit of $35,000—into the account beneficiary’s Roth IRA, without incurring the usual 10% penalty for nonqualified withdrawals or generating any taxable income.
2. Coverdell Education Savings Accounts (ESAs)
Coverdell ESAs might not get as much attention as 529 plans, but they’re worth considering:
- Tax Perks: Like 529s, your savings grow tax-free, and withdrawals for education expenses are also tax-free.
- Wide Usage: Coverdell funds can be used for K-12 expenses, including private school tuition and supplies.
- Limits to Watch: Annual contributions are capped at $2,000 per child, making it ideal as a supplement rather than a standalone option.
- Income Restrictions: Higher earners may not qualify, which could make this less practical for some families.
For families saving for private school or seeking an additional savings tool, Coverdell ESAs can be a valuable complement to a 529 plan.
3. Roth IRAs for Education
While Roth IRAs are traditionally considered retirement accounts, they can also be a creative way to save for education::
- Tax-Free Growth: Your contributions grow tax-free, and you can pull out your original contributions anytime without penalties.
- Education-Friendly: You can access earnings penalty-free if used for qualified education expenses.
- Dual Purpose: If your child doesn’t need the money for school, you’ve still got it earmarked for your retirement.
That said, Roth IRAs have yearly contribution limits ($6,500 per person under 50 in 2024) and income caps, which may make them less accessible for some families.
4. Regular Investment Accounts for College Savings
While a regular investment account obviously doesn’t carry the same tax benefits of a 529 Plan, it is also the most flexible and doesn’t carry any penalty for changing the intended use of the funds.
- Maximum Flexibility: Unlike 529 plans or ESAs, there are no restrictions on how you use the funds. If your child doesn’t attend college or you have other priorities, you can repurpose the money without penalties.
- No Contribution Limits: You can save and invest as much as you’d like, without the caps imposed by other accounts.
- Wide Investment Options: Regular accounts give you access to a broader range of investment vehicles, from individual stocks to ETFs and mutual funds.
- No Withdrawal Penalties: Withdraw funds whenever needed, for any purpose.
While regular investment accounts don’t offer tax advantages, their unmatched flexibility makes them an excellent complement to other savings strategies.
How do These Plans Compare to a Custodial Account?
What is a Custodial Account?
A custodial account is a popular type of savings or investment account that an adult—often a parent or guardian (account owner, custodian)—manages on behalf of a minor (beneficiary). These accounts, typically established under the Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA), can hold a variety of assets, including cash, stocks, bonds, mutual funds, and even real estate in some cases.
- Ownership: While an adult manages the account, the funds legally belong to the child, who gains full control of the account when they reach the age of majority (usually 18 or 21, depending on the state).
- Financial Flexibility: Unlike 529 plans, custodial accounts are not solely limited to education-related expenses. The funds can be used for any purpose that benefits the child, such as purchasing a car, covering medical expenses, or even funding a hobby.
- Tax Considerations: Earnings in custodial accounts are subject to the “kiddie tax,” where a portion of the income may be taxed at the parent’s rate, depending on the total earnings.
- No Contribution Limits: There’s no cap on how much money you can place in a custodial account, but keep in mind that significant contributions may trigger gift tax implications.
Comparing Custodial Accounts to the 529 Plan and ESA
When deciding between custodial accounts, 529 plans, and Coverdell ESAs, it’s essential to weigh their unique benefits and limitations based on your family’s goals and financial situation.
1 | Flexibility
Custodial accounts shine in terms of flexibility, as they aren’t restricted to education-related expenses. The funds can be used for a wide variety of purposes, including non-academic needs such as buying a car or covering medical bills.
529 plans and ESAs, on the other hand, are specifically designed for educational expenses, with penalties and taxes applied for nonqualified withdrawals. However, 529 plans have seen increased flexibility in recent years, now allowing funds to be used for K-12 tuition, apprenticeship programs, and even a Roth IRA rollover starting in 2024.
2 | Ownership and Control
One significant difference between these accounts lies in control and ownership. With a custodial account, the child becomes the legal owner when they reach the age of majority (typically 18 or 21, depending on the state). This means they have complete discretion over how the funds are spent.
Conversely, 529 plans and ESAs remain controlled by the account holder (usually a parent or guardian), ensuring the funds are used only for their intended purposes.
Tax Benefits
529 plans and Coverdell ESAs are both tax-advantaged accounts, as contributions grow tax-free, and qualified withdrawals for education expenses are also tax-free. Custodial accounts, however, are subject to the “kiddie tax,” which may result in part of the earnings being taxed at the parent’s rate.
Additionally, custodial accounts lack the robust tax benefits of 529 plans and ESAs, which can make a difference in long-term savings growth.
3 | Contribution Limits
Custodial accounts do not have contribution caps, though substantial contributions might trigger gift tax implications. On the other hand, 529 plans can have high contribution limits (often over $300,000 per beneficiary, depending on the state), while Coverdell ESAs cap contributions at $2,000 per child per year, making them more restrictive in terms of annual savings potential.
4 | Suitability
Custodial accounts provide the most financial flexibility, making them a good option for families who value open-ended use of funds and trust their child to manage the money responsibly in adulthood. 529 plans are ideal for families prioritizing education savings with tax benefits and long-term growth potential. Meanwhile, Coverdell ESAs are a niche tool, best suited as a supplement to a 529 plan for those seeking additional tax-advantaged savings for K-12 or college expenses.
What’s the Right Plan for You?
Every family’s needs are unique, and the best strategy often involves a combination of these options. For most families, a 529 plan serves as the backbone of education savings, while options like Coverdell ESAs, Roth IRAs, or regular investment accounts add flexibility and give you peace of mind.
Before making any decisions, it is wise to consult with a qualified tax advisor, financial planner, CPA, or investment manager.
At Towerpoint Wealth, we specialize in helping families like yours navigate these choices and create personalized education savings plans that align with your overall financial goals.
Ready to get started? Let’s map out a smart, personalized education savings strategy for your family’s future!
Frequently Asked College Savings Plans Questions
What is the best savings plan for college?
The best savings plan for college often depends on your family’s unique financial situation and goals. For many, a 529 plan stands out as the top choice due to its tax advantages, high contribution limits, and versatility for educational expenses. These plans are typically managed by a state-appointed program manager, who ensures the investments within the plan are professionally handled and aligned with long-term growth objectives. This makes 529 plans a reliable and efficient option for families looking to maximize their college savings.
What happens to 529 if the child doesn’t go to college?
If the child does not go to college, the funds in a 529 plan can still be used for other qualified education expenses, such as vocational or trade school costs, apprenticeship programs, or even transferred to another qualified beneficiary, such as a sibling. If the funds are withdrawn for non-qualified purposes, the earnings portion of the withdrawal will be subject to income tax and a 10% penalty. However, exceptions to the penalty may apply, such as when the beneficiary receives a scholarship.
