Best Alternatives to 529 Plans [Other College Savings Options]

All parents want their children to be successful in life, and the road to success often runs through a college campus. But, of course, college is expensive. So, for most families, covering a child’s higher education costs takes years of saving—often with a 529 plan.

529 plans are one of the most popular options when it comes to saving for college. The most attractive feature is that money in a 529 plan grows tax-free … as long as you ultimately use the funds for qualified education expenses.

However, while 529 plans are tax-advantaged accounts, they aren’t perfect. They don’t offer a lot of flexibility when it comes to spending the money in the account, investment options are limited, and you never know how well your investment will do.

So, for some families, there might be better ways to save for college—and I have a few suggestions. Below are my picks for the best alternatives to 529 plans. Consider all the options available and see which savings strategy, or combination of strategies, is the best fit for your family. You might find that a 529 plan is not the best (or only) choice for you.

Related: 11 Education Tax Credits and Deductions

How Does a 529 Plan Work?

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Before diving in on the other college savings options, let’s briefly review how a standard 529 plan works.

When you open a 529 account for a child or other person (you can open an account for an adult), the account is funded with “after-tax” dollars. Basically, that means there are no federal tax deductions, exclusions, or other tax breaks for contributions to the plan (although state tax breaks might be available), so you pay federal tax on the money before you put it in the account.

The money you put in a 529 plan is invested and, hopefully, increases in value (although you can lose money in a 529 plan). The good news is that funds in a 529 account generally grow on a tax-free basis. So, you’re not hit with a tax bill each year for any earnings.

You also don’t pay tax when withdrawing funds from the account, as long as the money is used for 529 plan qualified educational expenses—including up to $10,000 for tuition at eligible elementary and secondary (K-12) schools. If 529 plan funds are used for other purposes, a penalty applies and related earnings are considered taxable income subject to the same federal tax rates as wages, tips, taxable Social Security benefits, and other “ordinary” income.

If a 529 account is created for someone who doesn’t attend college or otherwise incur qualified educational expenses, unused 529 plan funds can be rolled over into a family member’s 529 account or ABLE account.

YATI Tip: Starting in 2024, a beneficiary can also roll over up to $35,000 of leftover money in a 529 plan into a Roth IRA in the beneficiary’s name. Any rollover is subject to annual Roth IRA contribution limits, and the 529 account must have been open for at least 15 years.

529s With Backer

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• Available: Sign up here
• Price: $1.99/contribution

A great 529 plan option to consider is Backer. Backer—a hassle-free 529 savings plan where your family and friends can play a role—has helped families save more than $30 million toward college in just minutes.

Backer allows you to invest in a portfolio of low-cost index funds that track major indexes of large-company stocks (S&P 500), small-cap stocks (Russell 2000), international company shares (MSCI EAFE Index), and U.S. government bonds (Barclays Aggregate Bond Index).

Interested in learning more or signing up? Visit Backer today.

Related: How Much to Save for Your Kid’s College

Best Alternatives to 529 Plans

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If you have a child who likely will attend college, it’s wise to start saving early for tuition and other education-related expenses. As noted, a 529 college savings plan is specifically designed for higher education savings, and it’s often a great savings option because it comes with tax benefits.

However, a 529 plan isn’t the only way to save for your kid’s college. You might also consider switching to or adding some of the following alternatives to 529 plans to your portfolio.

1. Custodial Accounts (UGMA/UTMA)

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With a custodial account, you can put cash or other assets in a special account for a minor. As the account’s custodian, you control it until the child reaches the age of majority—typically 18 to 21 years old, but possibly as late as 25 years of age, depending on the child’s state of residence.

Money can be withdrawn from a custodial account at any time, but it can only be spent in ways that directly benefit the minor.

Once the child reaches the age or majority, they become the owner of the account and can do whatever they want with the funds.

There are two main types of custodial accounts:

• Uniform Gifts to Minors Act (UGMA) accounts
• Uniform Transfers to Minors Act (UTMA) accounts

These custodial accounts generally function in the same way, but they have a couple of minor differences. For example, a UGMA account can only hold traditional financial assets, such as (but not limited to) stocks, bonds, mutual funds, exchange-traded funds (ETFs), and insurance products. UTMA accounts can hold those assets, plus property—say, real estate or cars.

YATI Tip: Even if a brokerage firm advertises both UGMA and UTMA accounts, you can’t open a new UGMA account today if you live in any of the 50 U.S. states or the District of Columbia. If you try to open a UGMA account, a UTMA account will be opened instead (although you can still own a UGMA account that was opened years ago).

There are a few significant advantages to using a custodial account to save for a child’s education. For example, as a brokerage account, money in the account can (and should) be invested. Invested capital has the potential to grow in value far more than money in a regular checking or savings account.

There’s also a great deal of flexibility when it comes to spending money in the account. Suppose the child doesn’t need the funds for higher education, but urgently needs money for a different expense. Unlike 529 Plans, there’s no penalty if the money is used for something unrelated to education and there are no early withdrawal fees.

There is a downside to using custodial accounts to save for college when it comes to a student’s financial aid eligibility. When applying for financial aid, custodial accounts are considered assets of the child, while 529 plans are typically considered assets of the parent. Since students are expected to use a higher percentage of their assets to pay for college (20%) than what their parents are expected to pay (up to 5.64%), the student’s Student Aid Index (SAI) will be higher with a custodial account than with a 529 plan. A higher SAI typically means less in financial aid.

Make sure you sign up for The Weekend Tea, WealthUp’s free weekly newsletter that over 10k monthly readers use to level up their money know-how.

Related: Best Ways to Invest $1,000 for a Child’s Future

Custodial accounts with EarlyBird

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• Available: Sign up here
• Price: $2.95/mo. for one child, $4.95/mo. for families with 2+ children

EarlyBird is a mobile app that allows parents and guardians to set up a custodial account, where they can quickly start investing for their children.

This app provides a convenient and inexpensive way to gift money to a child, with funds available to go toward any expenses that benefit the child. Family and friends can even record videos to go along with their financial contributions—a level of personalization that makes these moments last a lifetime.

EarlyBird allows you to choose from five strategic ETF-only portfolios, with investing goals ranging from conservative to aggressive, based on your stated risk tolerance and overall investor profile.

Consider opening an EarlyBird account today and receive $15 to get you started after opening your account.

 

2. Coverdell Education Savings Accounts (ESAs)

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A Coverdell Education Savings Account (ESA) is a type of investment account that makes it easier to pay education expenses for your children or loved ones.

Coverdell ESAs are similar to 529 plans. For instance, as with a 529 plan, contributions to a Coverdell ESA are made on an “after-tax” basis, money in a Coverdell ESA grows tax-free at the federal level if used for qualifying education expenses, and taxes must be paid on related earnings (along with a penalty) if funds in a Coverdell ESA are used for nonqualified expenses.

However, there are also some important differences between Coverdell ESAs and 529 plans. For example, unlike 529 plans, the following rules apply to Coverdell ESAs:

• Contributions to an account must be made before the beneficiary is 18 years old (except in the case of a special needs beneficiary).
• Annual contributions per beneficiary are limited to $2,000.
• The $2,000 annual contribution limit is gradually reduced to $0 if the contributor’s modified adjusted gross income (AGI) is between $95,000 and $110,000 ($190,000 to $220,000 for married couples filing a joint tax return).
• Funds in the account must be distributed by the time the beneficiary reaches age 30 (except in the case of a special needs beneficiary).
• There’s no limit on distributions used for K-12 school expenses.

Because of the additional restrictions on contributions, Coverdell ESAs aren’t as popular as 529 plans. However, if you’re saving for K-12 education costs, a Coverdell ESA might be a better option since there’s no limit on distributions for these expenses. Money from a Coverdell ESA can also be used for more than just K-12 tuition.

Coverdell ESAs typically offer more investment options and control, too. This might be an important consideration for some families.

3. Prepaid Tuition Plans

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Prepaid tuition plans (also called guaranteed savings plans) are actually a type of 529 plan. However, we’re treating them as an alternative to traditional 529 plans since they work differently.

While not available in every state, prepaid tuition plans allow you to lock in current tuition rates for college expenses incurred years from now. You can often purchase anywhere from one semester to four years of college in advance with a prepaid tuition plan. When the beneficiary is ready to attend college, the plan will cover eligible expenses while the beneficiary is in school and pay the educational institution.

So, unlike standard 529 plans, a prepaid tuition plan protects you from rapidly rising tuition rates in the future. That’s the main benefit of these plans. But they’re also a lower-risk option, since you’re not subject to the same kind of investment loss associated with standard 529 plans.

On the other hand, a prepaid tuition plan only covers tuition and fees. It generally can’t be used to pay for other higher-education expenses, such as room and board.

As with standard 529 plans, there’s no tax deduction for contributions to a prepaid tuition plan (i.e., money is put into the account on an “after-tax” basis). But there’s also no tax on earnings or distributions for qualified educational expenses.

Prepaid tuition plans are typically state-run plans set up to pay tuition at in-state colleges and universities. However, if the beneficiary ends up attending an out-of-state or private school, you can usually transfer the value of a prepaid tuition plan to the other school.

There’s also a prepaid tuition plan offered by a group of nearly 300 private school members from across the country. It’s called the Private College 529 Plan, and might be a good option for kids who have their heart set on attending one of the participating private colleges or universities.

4. Roth IRAs

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Roth IRAs are best known for retirement savings, but they’re also an excellent option for funding your child’s college expenses. The tax advantages are similar to those for 529 plans. However, you’ll have more investment options with a Roth IRA than with a typical 529 plan. Another bonus is that any money not used toward education can stay in the account as retirement funds.

From a tax perspective, contributions to a Roth IRA are made on an “after-tax” basis, so you don’t get a tax break when you put money into the account. However, contributions and earnings grow tax-free.

You also never have to pay taxes when you withdraw contributions. Withdrawals of earnings are subject to income tax if you tax money out of the account before you turn 59½ years old.

In addition, withdrawing earnings before age 59½ generally results in a 10% penalty. However, the penalty doesn’t apply if the money is used for qualified higher-education expenses for either:

• Yourself
• Your spouse
• Your or your spouse’s child, foster child, or adopted child
• Your or your spouse’s grandchild

Keep in mind that you can only contribute to a Roth IRA if you have earned income. As a result, if a Roth IRA is opened in a child’s name, the child needs to have some type of work that makes them money.

There are also annual contribution limits for Roth IRAs that might make it difficult to save enough for a pricey college education. The 2023 contribution maximum is $6,500 for everyone under age 50, but it rises to $7,500 if you’re 50 or older (these limits apply to the total amount contributed to all IRAs you own). However, the maximum amount is gradually reduced to zero if your 2023 modified AGI is:

• $138,000 to $153,000 if you use the single or head of household filing status on your tax return
• $218,000 to $228,000 if you’re married and file a joint return
• $0 to $10,000 if you’re married but file a separate return

For 2024, you can put up to $7,000 in your IRAs for the year if you’re not yet 50 years old. If you’re at least 50, you can contribute as much as $8,000. These maximums are phased out if your 2024 modified AGI is:

• $146,000 to $161,000 for single and head-of-household filers
• $230,000 to $240,000 for joint filers
• $0 to $10,000 for married couples filing separately

Roth IRA funds aren’t included in financial aid calculations, but withdrawals count and can affect the amount of aid awarded.

YATI Tip: You have until the tax filing deadline for the year to make contributions to a Roth IRA. So, for example, you have until April 15, 2024 (April 17 for residents of Maine and Massachusetts) to put money in an IRA for the 2023 tax year. If you request an automatic filing extension for your 2023 tax return, you’ll have until Oct. 15, 2024, to contribute to an IRA for the 2023 tax year. Similar deadlines will apply for 2024 IRA contributions.

Related: 10 Best Investments for Roth IRA Accounts

E*Trade Roth IRAs

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• Available: Click “Open Account” below
• Price: $0 commission trading online for U.S.-listed stocks, ETFs, options, mutual funds, and Treasuries

Most people know E*Trade as one of the leading providers of brokerage accounts, but you can also put the powerful platform to work saving for your child’s education.

Within an E*Trade Roth IRA, you can build a personalized portfolio through thousands of stocks, bonds, ETFs, and mutual funds, or you can have E*Trade select your holdings for you through its Core Portfolio robo-advisory service ($500 minimum investment).

Just like with its individual brokerage accounts, E*Trade Roth IRAs offer zero-commission stock, ETF, and options trading. It also has a leg up on some platforms by offering $0-commission mutual fund, Treasury, and new-issue bond trading.

And if you want to learn more about investing—or want your young one to learn alongside you—E*Trade also boasts educational resources, including articles, videos, classes, monthly webinars, and even live events.

Read our review to learn more, or visit E*Trade and sign up by clicking “Open Account” below.

 

5. High-Yield Savings Accounts

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If you’re looking for the ultimate in flexibility and low risk, there’s always a traditional savings account with a bank.

You can put in as much as you want (although be mindful of FDIC insurance limitations), withdraw funds almost any time you want, and use the money for whatever you wish.

It’s also a safe bet. Unlike 529 plans and other investment accounts, there’s generally no chance of losing money in a savings account if you fall within the FDIC’s $250,000 of insurance coverage per depositor.

But, of course, the downside is that your return on investment is going to be low with a savings account. And with the sky-high cost of higher education these days, most people probably won’t see the type of growth they need to save up enough money for college.

You’ll also miss out on the tax savings available with 529 plans and some of the other methods for saving for college.

Nevertheless, if you do decide to put money in a savings account to beef up funds for higher education, at least consider a high-yield savings account. With a high-yield account, you’ll accumulate more money for college than with a standard savings account.

High-yield savings accounts often pay upwards of 15 to 25 times the national average of a standard savings account. They are also typically offered by online-only banks because of their lower cost structure than brick-and-mortar banks.

The interest rates for high-yield savings accounts are variable, so the rate you sign up for might change. However, even if your rate goes down, it will likely still be significantly higher than the rate of a standard savings account.

Consider placing your money in one of the most competitive high-yield savings accounts available on the market through CIT Bank. It offers an easy application process (about five minutes), extremely competitive rates, no service fees, and mobile banking functionality.

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6. Savings Bonds

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Savings bonds are loans to the U.S. government. When you purchase a U.S. savings bond, you get your principal back, plus interest, when you cash in the bond or it reaches full maturity. You can cash in a bond after one year, but you’ll lose three months of interest if you cash it in before five years.

For Series EE and I bonds, the interest is only taxed at the federal level. They’re not subject to state or local income tax in most situations. You can also choose to pay federal tax on the interest earned each year or wait to pay tax on all the interest when you cash in the bond.

But here’s what makes savings bonds a good choice if you’re saving for college: If the money is used for qualifying education expenses, you won’t have to pay any tax on the interest if all of the following requirements are satisfied:

• You were at least 24 years old when the bonds were issued.
• Your modified adjusted gross income is less than the cut-off amount for the year in which you claim the exclusion ($167,800 for joint filers and $106,850 for everyone else for 2023; $175,200 and $111,800, respectively, for 2024).
• You cash in the savings bonds in the same tax year for which you claim the exclusion.
• You paid qualified higher education expenses to an eligible institution that same year.
• The expenses were for yourself, your spouse, or someone you list as a dependent on your federal income tax return.
• You don’t use the married filing separately filing status on your federal tax return.

Savings bonds are considered one of the safer investment options, meaning you can rest assured that the child will get the amount of money they’re promised.

U.S. savings bonds are also easy to purchase online at TreasuryDirect. Once they’re bought and gifted, all you have to do is wait until they mature for the child to cash in and use the funds. You don’t need to actively buy and sell any financial assets frequently.

7. Trusts

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Setting up a trust fund to pay for higher-education expenses can offer more flexibility than a 529 plan. However, trusts set up for educational expenses are often irrevocable, so you might not be able to designate funds for college and then change your mind later.

With regard to greater flexibility, trusts offer more investment options than 529 plans, which are usually more limited in their investment options. With a 529 plan, only cash contributions are allowed, but you can put stocks, bonds, and other investment assets in a trust.

You’ll also have more choices with a trust than with a 529 plan when it comes to when and how money and assets in the trust are used. For instance, you can set up a trust so that some funds are to be used on tuition and fees, while other funds are used for other expenses, such as housing or medical expenses.

On the other hand, a trust might make it harder for the beneficiary to qualify for financial aid. Trust funds are generally treated as the beneficiary’s asset. As noted earlier, the beneficiary (student) is expected to use a higher percentage of their assets to pay for college than what their parents are expected to pay, which means the beneficiary’s expected family contribution will be higher with a trust than with a 529 plan.

Trusts also aren’t a quick and easy way to save for college, and there are additional costs associated with them. For instance, you’ll need to hire an attorney to set up the trust, and you might also want to consult with a financial advisor as well.

Related: Student Loan Interest Deduction: How Much, Eligibility + More

Additional Questions About 529 Plans

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As you learn more about alternatives to a 529 plan—or ways to save for college in conjunction with a 529 plan—you might have additional questions about 529 plans. So, to fill in some gaps, here are a few additional FAQs on 529 plans.

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Is there a limit on how much you can contribute to a 529 plan?

There’s no specific dollar-amount limit on annual contributions to a 529 plan under federal law. However, a 529 plan must provide adequate safeguards to make sure that total contributions for any single beneficiary aren’t more than the amount necessary to provide for the beneficiary’s qualified education expenses. As a result, state 529 plans tend to establish their own aggregate contribution limits based on expected costs in the state.

Estate and gift tax limits

There might also be federal gift and estate tax consequences if you put too much into a 529 plan during the year.

Contributions to someone else’s 529 plan are considered “gifts” for federal gift tax purposes. There’s an annual gift tax exclusion—$17,000 for 2023; $18,000 for 2024. If your gifts to any one person during the year exceed the annual exclusion amount, you must report the gifts to the IRS and possibly pay tax on them.

Any amount reported as a gift to the IRS is also subtracted from your lifetime gift tax exclusion and federal estate tax exemption, which are both $12.92 million for 2023 ($25.84 million for married couples) and $13.61 million for 2024 ($27.22 million for married couples).

There is one way around the annual gift tax exclusion. You can contribute five year’s worth of gifts to a beneficiary’s 529 plan in one year (i.e., up to $85,000 for 2023 or $90,000 for 2024) without having to pay gift tax or having the excess counted toward your lifetime exclusion or estate tax exemption (although you still have to report the gift to the IRS).

Related: How to Give Stocks as a Gift in a Tax-Efficient Way

What are qualified education expenses for 529 plan purposes?

There’s a wide variety of qualified education expenses for which you can use 529 plan funds, such as:

• Tuition and fees
• Computers, software, and internet access
• Books
• Student loan payments (up to a total of $10,000)
• Special needs equipment
• Room and board (for students enrolled at least half-time)
• Elementary or secondary school tuition (up to a total of $10,000)

You can’t use money from a 529 account to pay for health insurance, transportation, extracurricular activities, college application fees, or any other expenses not directly related to the account beneficiary’s education.

What’s the penalty for using 529 plan funds for non-qualified expenses?

Suppose you have an urgent expense that isn’t education-related and want to tap into your child’s 529 plan. You can withdraw money at any time, but non-qualified withdrawals are subject to a 10% tax penalty. You also have to pay income taxes on the earnings.

Waiver of penalty

The penalty is waived if the 529 plan beneficiary:

• Dies
• Becomes disabled
• Attends a U.S. military academy
• Earns a tax-free scholarship or fellowship grant
• Receives veterans’ educational assistance, employer-provided educational assistance, or any other tax-free payments as educational assistance

There’s also no penalty if a distribution is included in income only because qualified education expenses were taken into account in determining the lifetime learning or American Opportunity tax credit.

Can you invest in stocks with a 529 plan?

Usually, 529 plans give you just a few different options of stock and bond funds. You can’t buy individual stocks for your 529 account.

Are age-based investing options available with a 529 plan?

Many 529 plans let you pick an investment option that automatically takes a more conservative approach as your child’s college enrollment gets closer, similar to target-date funds people use for retirement.

However, some 529 plans require you to rebalance the account yourself.

What state tax breaks are available for contributions to a 529 plan?

Most states also offer a partial or full tax deduction or credit for contributions to in-state 529 plans. Some states also provide tax breaks for contributions to any state’s plan.

Check with the state tax agency where you live to see if your state offers tax breaks for 529 plan contributions.

When should parents stop contributing to a child’s 529 plan?

You don’t need to stop making 529 plan contributions once your child reaches a certain age. You can even continue contributing when your child is in college … just in case your child goes to grad school. However, you’ll want to stop investing in the plan at some point.

You may choose to stop investing in a 529 plan once you’ve reached your savings goal. Sure, more money is always useful, but once you have enough for all the major college expenses, such as tuition, it may be wise to stop investing the money so you don’t risk losing some of it.

After all, having excess funds that are not used for qualified education expenses can result in a 10% penalty.

Related:

• 30 Tax Statistics and Facts That Might Surprise You
• How to Make Money as a Teenager
• Kiddie Tax: What Is It, Who Must Pay, How Much + More