College Savings: 529 Plan Alternatives

529 plan alternatives

Many parents lose sleep at night worrying about how they will afford college. Is a 529 plan right for them, or should they consider 529 plan alternatives?

This is completely understandable.

Parents want their children to be successful, and a college education is one way to boost their chances of success.

According to the Association of Public and Land-Grant Universities, “The evidence that a college degree significantly improves one’s employment prospects and earnings potential is overwhelming. Bachelor’s degree holders are half as likely to be unemployed as their peers who only have a high school degree and they make $1 million in additional earnings on average over their lifetime.”

While a college degree is not the be-all and end-all for success, numbers like these are why many parents are hoping their children earn a college education.

But…a college education isn’t cheap. Far from it! 

Consider these statistics from U.S. News representing the rise in college costs over 20 years:

  • The average tuition and fees at private National Universities have jumped 144%.
  • Out-of-state tuition and fees at public National Universities have risen 171%.
  • In-state tuition and fees at public National Universities have grown the most, increasing 211%.
  • The total consumer price index inflation increased by around 54% from July 2001 to July 2021.

Hence the reason parents lose sleep over saving money for college.

We know that parents are actively trying to save money for college by searching for the best college savings plan.

And, as of 2021, “30% of saving accounts are 529 plans – the largest majority.”

[Related Read: How a 529 Plan Works for College Savings]

With that being said, 529 plans are not the only vehicle for saving for college.

Check out these 529 plan alternatives to see which is the best choice for you.  

What Are 529 Plans?

A 529 plan is a tax-advantaged saving plan that may be used to pay for qualified education expenses, including college tuition, apprenticeship programs, and K-12 grade education, for a designated beneficiary.

In addition, 529 plans may be used to pay for qualified education expenses, including room and board and computers.

A big benefit is your savings growth is tax-deferred and withdrawals are tax-free as long as they are withdrawn for qualified education expenses.

While there are many benefits to a 529 plan, there are also disadvantages, such as the fees. 

529 plan fees can add up, as determined by the maintenance and investment management fees and expense ratio.

That’s why it is wise to research 529 plan alternatives. 

[Related Read: Pros and Cons of a 529 Plan]

Coverdell Education Savings Account

Known as the Education IRA until 2002, the Coverdell Education Savings Account is one of the popular 529 plan alternatives.

Similar to 529 plans, the Coverdell Education Savings Account offers tax-free investment growth and tax-free withdrawals for qualified educational expenses. 

One of the distinguishing features of the Coverdell Education Savings Account is the ability to use the money for educational expenses beyond tuition for K-12 (such as books and supplies).

Anyone can set up an account for a beneficiary, as long as the beneficiary is under 18 years of age. No relation is necessary.

However, the Coverdell Education Savings Account has income stipulations. 

Saving for College explains, “Contributors must have less than $190,000 in modified adjusted gross income ($95,000 for single filers) in order to qualify for a full $2,000 contribution.”

You can open both a Coverdell Education Savings Account and a 529 plan. You can also withdraw funds from the Coverdell Education Savings Account to make contributions to a 529 plan.

UGMA Accounts (Uniform Gift to Minors Act)

Established in 1956 and revised in 1966, the Uniform Gift to Minors Act was created to allow individuals to gift or transfer assets to children in place of setting up a trust fund.

However, unlike other financial gifts, UGMA does not require a gift tax up to a certain amount

An adult custodian manages a UGMA account until the child reaches a certain age (this varies state by state, but is generally between 18 and 21), and the adult custodian can manage the financial assets in the account.

Anyone can contribute with UGMA accounts once the account is set up, and there are no contribution limits.

Another reason UGMA accounts are 529 plan alternatives is that there are no withdrawal penalties.

However, since UGMA are assets, they may decrease federal financial aid eligibility

It is important to note that while many parents set up UGMA accounts with the intention of using the funds to pay for college expenses, the money is fully the child’s once he or she comes of age. 

That means the child can use the money however he or she wants to – not necessarily for college. 

Roth IRA

A Roth IRA is an individual retirement account in which money grows tax-free

The account is funded with after-tax money. Your money grows depending on the investments chosen, and then your withdrawals in retirement are tax-free.

The Roth IRA allows those with earned income below a certain level (single individuals earning below $140,000 or married couples earning below $208,000) to contribute.

For 2022, the total contributions you make each year to a Roth IRA is $6,000 ($7,000 if you are age 50 and older).

While it is a retirement account, it is also a vehicle for college savings because qualified education expenses may be withdrawn tax-free and penalty-free.

The following are qualified higher education expenses for Roth IRA penalty-free withdrawals:

  • Tuition
  • Fees
  • Books
  • Supplies
  • Required equipment 
  • Expenses for special needs services 

Watch This Roth IRA Full-Explanation Video to Learn More.

Prepaid Tuition Plans

The appeal of this 529 plan alternative is the ability to lock in today’s tuition rates.

With a state-sponsored prepaid tuition plan, you can contribute regularly or a lump sum to an account to pay for college in the same state where the account was opened at the current rates.

Since college tuition rates are rising at staggering rates, this is an option worth considering.

However, it is not an option for everyone.

Currently, only nine states offer prepaid tuition plans.

The key is that the student must attend an eligible college or university within the same state where the account was opened, and the account must be opened while the child is 15 years old or younger. 

Keep in mind that these are referred to as tuition plans, which means the majority of them only allow the funds to be used for tuition and may not be used for room and board. 

Investment Accounts

When it comes to 529 plan alternatives, some parents choose to do things their own way with investment accounts.

For example, parents may opt to use mutual funds instead of 529 plans. 

This is because mutual funds tend to offer higher overall returns at a lower cost.

With 529 plans, you have to pay fees to manage the account, some of which are rather expensive.

However, even with this selling point of a higher overall return, it is important to recognize that your investment accounts may end up hurting your child financially.

As you withdraw funds from investment accounts, they increase your income. As a result, your child’s financial aid may be penalized.

Indexed Universal Life Insurance

Many financial advisors focus on selling Indexed Universal Life Insurance just for college planning. 

This is because it is NOT considered an asset, so it won’t go against your child when applying for financial aid.

It is taxed like a Roth IRA, with contributions from after-tax dollars. It allows for tax-deferred growth and may be able to provide tax-free distributions. 

However, like any other type of life insurance, the fees and costs add up. 

Want more information on 529 plan alternatives and college savings accounts for you and your child? Watch our videos on YouTube!

No Comments

Post A Comment