A Look: 529 Plans and Alternative Options For Education Expenses
529 plans are popular education-savings tools due to their tax-deferred growth and tax-free withdrawals for qualified expenses, such as tuition and books. They offer generous lifetime contribution limits, which vary by state, and have been made more flexible with new rules allowing funds to be used in some states for K-12 tuition and in certain circumstances reallocated to a Roth IRA. However, some parents seek alternatives due to uncertainties about their child’s education plans or the desire for more financial flexibility.
529 Plans
529 plans are state-sponsored programs that allow individuals to invest in another person’s education, covering expenses from kindergarten through college. The account owner retains control over the funds, while a state-assigned fund manager directs the investments. These plans offer various portfolio options, including age-based and static porfolios, to suit different risk preferences. Opening a 529 account is accessible, with options to start with small contributions and automatic investing plans. The tax advantages include federally tax-deferred growth and tax-free withdrawals for qualified expenses, though contributions are not federally tax-deductible.
Contributions up to $19,000 (for 2025) annually (or $38,000 for couples) are allowed without incurring gift tax, with thepossibility of larger upfront contributions that are deemed to be spread over five years (super funding). For student financial aid purposes, 529 plans are considered the account owner’s asset, not the child’s, resulting in a lesser inclusion rate in the Student Aid Index (SAI) (note: grandparent owned 529 plans generally are not included in the SAI). Note that if a child receives a scholarship, withdrawals from a 529 account may incur taxes and penalties on earnings above contributions. In some circumstanes, prepaid tuition plans may be an alternative within 529 plans, allowing prepayment of tuition at today’s prices for in-state public schools.
Alternatives to 529 Plans
Taxable Brokerage Accounts Taxable brokerage accounts offer flexibility with no contribution limits and no requirement to spend funds on qualified education expenses. However, they are counted as assets for federal financial aid purposes, potentially impacting aid eligibility. There is no tax-free growth or withdrawals, but tax-efficient investing strategies can
mitigate taxable interest and dividends.
Roth IRAs
Roth IRAs, typically used for retirement, in certain circumstances can be tapped for qualified education expenses of a child. Contributions can be withdrawn tax-free at any time, and earnings can be withdrawn tax-free and penalty-free for qualified education expenses if the account has been open for at least five years. Contribution limits and income
restrictions apply, making it less suitable for late savers. Using retirement savings for education requires careful consideration of retirement needs.
UGMA/UTMA Accounts
UGMA and UTMA accounts are custodial accounts for minors, with no contribution limits and funds are not restricted to education. They have a significant negative impact on financial aid, as they are considered student assets. Control of the account transfers to the child for UGMA accounts at age 18 or 21, depending on the state (age of majority), and for UTMA accounts at the age of majority or as late as age 25 in some states, which may be undesirable for some parents.
Whole Life Insurance
Whole life insurance can be used for college funding by borrowing against the cash value accumulated in the policy. It offers flexibility, but borrowing reduces the death benefit and may have tax consequences if the policy lapses. Funding a policy requires a long-term commitment, and returns are typically lower than other investments. Premiums are often higher than other investment options due to various costs.
Conclusion
While 529 plans offer significant tax advantages and flexibility for education savings, alternatives like taxable brokerage accounts, Roth IRAs, UGMA/UTMA accounts, and whole life insurance provide varying degrees of flexibility and financial aid impact. Parents should consider their financial goals, risk tolerance, and potential impact on financial aid when choosing the best option for their family’s education savings needs.
Related Attorneys
