Another great benefit of 529 plans is that you can transfer them to other siblings. If you’re lucky enough to have a child that earns a lot of scholarships, you can move his or her 529 plan balance to another family member.
Alternatives to 529 College Savings Plans
There are several options for parents if you didn’t want to invest in a 529 College Savings Plan. Below are four of the most popular alternatives that you may want to consider.
- Coverdell Education Savings Accounts
- UGMA/UTMA Accounts
- Prepaid Tuition Plans
- Prepaid Tuition Plans
Coverdell Education Savings Accounts
A Coverdell Education Savings Account (ESA) allows parents to invest in almost any type of security – stocks, bonds, mutual funds, etc. With a Coverdell ESA, the plans do not lock parents into the limited investment choices of a 529 plan. Like 529 plans, a Coverdell ESA allows parents to invest with after-tax dollars and withdrawal earnings tax-free for educational expenses. You can also use an ESA for private elementary and secondary school as well as college costs.
One drawback of a Coverdell ESA is its low contribution limits. Parents can only invest $2,000 each year in a Coverdell ESA. There is also a mandatory withdrawal at the age of 30 unless you transfer the benefits to another family member.
The Uniform Gift to Minors Account (UGMA) and Uniform Transfer to Minors Account (UTMA) are accounts set up by the parent, but they are ultimately an asset of the child. Unlike a 529 College Savings Plan, parents have wide latitude on what they can invest in. You have almost unlimited investment choices with UGMA/UTMA accounts, but these accounts do not have the same tax benefits as a 529 plan.
The federal government taxes UGMA/UTMA accounts at the child’s tax rate when withdrawn. And, the child does not have to specifically use the account for college despite that being the initial intent. Because UGMA/UTMA accounts are considered assets, they could also impact the amount of need-based financial aid colleges award. 529 College Savings Plan balances are exempted from the calculations.
Prepaid Tuition Plans
I went to a small liberal arts private college in South Carolina. For the longest time, I invested for my children in the Private College 529 Plan, which is a prepaid tuition plan that caters solely to private colleges in the United States.
With prepaid 529 plans, you purchase credits or semesters at today’s prices. You are literally prepaying tuition for your child’s college. If you use prepaid 529 plans, you are betting that the cost of college will be higher when you children finally attend.
One issue for prepaid 529 plans is that the plans often lock you into using the credits that you’ve prepurchased only at participating colleges. But, if you change your mind down the road, you can transfer your account balance to a more traditional 529 College Savings Plan sponsored by a state if you choose.
Finally, you are always free to invest for your children’s college education in taxable accounts. With taxable accounts, the parents hold the investment in their names, and the parents are free to disperse the funds as they see fit for any expense.
There are tax benefits or penalties associated with taxable accounts. But, colleges will use the account balances against you when calculating need-based financial aid.
529 College Savings Plans can be a great way for parents to save for college education. There are many tax benefits associated with a 529 plan from reduced state income tax to tax-free withdrawals. 529 College Savings Plans allow parents to invest the funds in several different mutual funds with diversity and grow tax-free.
But, there are other options out there if parents want to go a different route to save for college. It’s important to understand the choices and make the best one for your family and situation.