What is it?
A 529 education savings plan comes with tax benefits when the money is used for qualified education expenses. Plan rules and options vary by state.
Who is it best suited for?
For most people, a 529 plan is the best option for saving for education. You can read more about its benefits here.
Why would I not choose this option?
Money withdrawn for nonqualified expenses is subject to federal taxes and a 10% penalty unless an exception applies. States may also impose their own taxes and penalties. Because of this, other types of accounts that provide more flexibility for unused balances may be a better fit if:
- You have amounts you want to save for education but aren’t confident they’ll be used for qualified education expenses, and
- You won’t qualify for or want to use the flexibility options for unused 529 balances.
What is it?
A taxable investment account offers no tax benefits but also has no limitations for contributions or distributions. An account can be set up specifically to fund education.
Who is it best suited for?
Taxable investment accounts are best suited if you desire maximum flexibility for your savings and are willing to give up tax benefits for that flexibility. Because there are no restrictions on how the money is used, it can easily fund another goal if not used for education.
Why would I not choose this option?
You want to maximize your savings by taking advantage of tax benefits.
What is it?
A Roth IRA is designed to save for retirement, but for some it may be an attractive option to save for education.
How are withdrawals treated?
Contributions are always tax- and penalty-free. When taking withdrawals, contributions are assumed to be distributed first (before any earnings). Earnings are generally tax- and penalty-free if you’re 59½ or older and it’s been at least five years since you first funded a Roth IRA.
Who is it best suited for?
If eligible to contribute, using a Roth IRA for college may be an appropriate alternative or supplement for those who still want tax benefits for their savings but are concerned about overfunding a 529. As with a taxable account, it can be useful for college-related expenses that aren’t considered qualified education expenses for a 529. Additionally, one of the following should be true:
- At the time you’ll want to access the funds, you’ll have met the five-year rule and you’ll be age 59½ or older, or
- You’re willing to take only contributions from the account.
Why would I not choose this option?
- You don’t meet the criteria above. The tax impact of withdrawing earnings will make other savings options better.
- You prefer or need to use an IRA to save for your own retirement.
- You’re reliant on need-based financial aid in future years. Distributions from a Roth IRA are counted as income in the financial aid calculation, so this may not be the best option.
What is it?
An education savings bond is issued by the U.S. Department of the Treasury as a Series EE or Series I bond.
Who is it best suited for?
Education savings bonds can complement other account types for those who find the stability of a government bond attractive.
Why would I not choose this option?
- You want more growth potential for your savings. These bonds generally offer a low rate of return.
- You want more kinds of education expenses to qualify for the tax benefits. For instance, expenses such as room and board and books, which can qualify for favorable tax treatment for a 529, will not qualify for favorable tax treatment for education savings bonds.
- You expect your income may be above the phaseouts to qualify for the tax benefits .
What is it?
A Coverdell education savings account is an investment account that can be used to save for elementary, secondary and higher education costs. As with a 529, withdrawals for qualified education expenses are tax free. Withdrawals for nonqualified expenses are subject to a 10% penalty and taxes unless an exception applies.
Why is this recommended only in limited circumstances?
- Coverdell accounts have lower contribution limits, fewer tax benefits and fewer options for unused balances than 529 plans.
- Funds must be fully withdrawn by the time the beneficiary reaches age 30. If not, within 30 days the balance will be paid to the beneficiary less taxes and a 10% penalty.
When might it be appropriate?
A Coverdell account is best suited for someone who wants a wider range of investment options than what a 529 plan offers. Because of the very low contribution limit, it’s likely you’ll only be able to pay partially for education unless you supplement with other savings.
What is it?
An adult opens a custodial account for a minor and retains control until the minor reaches a certain age (18 or 21, varies by state). Any money put in is irrevocable and can be used only for the benefit of the beneficiary. The beneficiary cannot be changed.
Once the beneficiary reaches the age of termination (the age the account is transferred to the child’s control), they own the funds and can use them for any purpose.
Why is this recommended only in limited circumstances?
- Once the minor gains control of the account, they can use the funds for any purpose.
- Financial aid calculations treat it as the student’s asset, so it has a greater effect on financial aid eligibility.
- There are no tax benefits to using it for education expenses.
When might it be appropriate?
Custodial accounts prioritize who receives the savings over how the savings are used. This could make sense for blended families or other situations where there is concern around the beneficiary of the account (e.g., a grandparent wants to ensure a particular grandchild receives the funds).