It’s graduation season again. The school year seems to fly by and then it’s the start of the busy summer vacation season. However, as you watch another school year come to a close, you may be thinking to yourself, “am I saving enough for my child’s future higher education costs?” Or, “I have a 529 plan for my child, but is that the best option for my situation?” You may also not yet have started saving proactively for higher education costs and are wondering if it makes sense to start now and if you have adequate time left. Saving for a child’s future education costs is something that can easily be put on the backburner for a later date, but now may be a good time to review options that are available and put a plan in place. Let's explore a few potential alternatives to consider that aren't a 529 plan.
Coverdell Education Savings Account (ESA)
While I still believe that 529 plans offer the most benefits for saving for higher education costs, I realize that this type of account may not suit everyone’s situation. Coverdell ESAs offer some features that 529 plans don’t have. The biggest difference is that they can be used without limitation for qualified education expenses for kindergarten through college, whereas, 529 plans limit annual withdrawals for K-12 students to $10,000 per year for tuition only (and some states don’t conform to this so you may still face state taxes and penalties on withdrawals from 529 plans that are used for K-12 expenses). Coverdell ESAs also allow the potential to invest in a broader universe of investments than just mutual funds (which is typically your only investment option for 529 plans). There are some downsides to ESAs, namely the low annual contribution limit of $2,000 per year and the ability to contribute to an ESA at all may be limited (or completely eliminated) if your income is too high. They must also generally be fully used by the time your child reaches the age of 30.
UTMA/UGMA Accounts
Before 529 plans, parents often used to utilize UTMA (Uniform Transfer to Minor Act) or UGMA (Uniform Gift to Minor Act) accounts as savings vehicles for higher education expenses. These are custodial accounts that allow parents to set aside money for their child’s benefit and they offer a lot of flexibility in how the account is invested relative to 529 plans. They also don’t require the funds to be used specifically for higher education expenses, so they provide a middle ground for parents who are unsure if their child will ultimately continue their education beyond high school.
While these accounts are still available, there are significant drawbacks to them that generally make them unappealing to most parents/grandparents. The biggest downside is that these accounts are controlled by whoever is the custodian (most likely the parent) until the child reaches “the age of majority” which varies state by state but can be as young as 18. After the child reaches that age, the custodian must relinquish control to the child and they are free to use the account as they please (could be college or could be a new car, their choice). While the custodian is responsible for managing the account until the minor child reaches the age of majority, all contributions that are made to the account are deemed as gifts to the minor child and cannot be taken back in the future. UTMA/UGMA accounts also don’t have the same tax benefits as 529 accounts. Investment earnings beyond a certain annual amount are taxable. Lastly, they are deemed to be assets of your child (student) which could potentially negatively impact their student aid potential more so than a 529 account that is owned by the parent.
Roth IRAs
Roth IRAs, while meant to be used for retirement savings, can potentially be a source to pay for higher education expenses. However, before even considering tapping into a retirement account to fund your child’s higher education costs, you should make sure you have adequate savings to fund your current (or eventual) retirement. Roth IRAs allow for contributions (not earnings) to be withdrawn at any time without taxes or penalties. The earnings portion can potentially be tax and penalty free if you’re over 59 ½ and your Roth IRA has been open for at least 5 years. If you don’t meet the criteria for tax and penalty free withdrawals on the earnings portion, Roth IRAs do potentially allow for a penalty free withdrawal of earnings if used for a qualified education expense. However, you’d still owe taxes on the withdrawal. The other downside to Roth IRAs is that their annual contribution limit is relatively low (for 2025 it’s $7,000 a year if you’re under 50 and $8,000 a year if you’re over 50) and you may be ineligible to make a direct Roth IRA contribution if your income is too high.
General Taxable Investment Account
A taxable investment account allows you the most flexibility with how to invest and also allows you options if your child ultimately decides to forgo higher education. The main downside of using a taxable investment account is you give up some of the tax benefits that 529 plans provide if you do ultimately use the funds to pay for a child’s higher education expenses. Remember, investment earnings in a 529 plan are tax deferred on a year-to-year basis and potentially tax free when used to pay for qualified education costs. This is not the case with a regular investment account. You will need to report investment activity (dividends, interest, capital gains, etc.) on your taxes annually. However, if your child chooses not to pursue higher education, you won’t be subject to penalties in a taxable investment account that you would otherwise if you made withdrawals from a 529 plan that were deemed “non-qualified.”
There are several types of accounts to consider when looking to save for higher education costs and it's not one size fits all. Everyone's situation is different. As we end graduation season, now is a great time to review your current plan or consider starting to invest for your child or grandchild’s future education costs.
Securities and Advisory Services offered through LPL Financial, member FINRA/SIPC, a Registered Investment Advisor. LPL Financial and Croxall Capital Planning do not provide tax or legal advice. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Prior to investing in a 529 Plan, investors should consider whether the investor's or designated beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state's qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.