Ways to Save for College Other Than a Traditional 529 Plan

Saving for college can be stressful. After all, it generally comes much earlier than retirement, but like your retirement, it requires substantial funds. As a result, college requires you to save a lot and, in many cases, do so quickly. While scholarships and various programs can help cut costs significantly, you will still need to figure out a way to pay for your education. Whether you want to go to night classes in your free time or attend an Ivy League university, you will need to figure out how to pay for it.

One of the most common and effective methods to save for college is the 529 plan. But what exactly is a 529 plan? How does it work? And are there any comparable alternatives? Let’s take a look at the traditional 529 plan and other alternatives to help jump-start college savings plan.

What is a 529 Plan?

A 529 plan is a special account designed to save for higher education costs. Similar to a Roth IRA, withdrawals are tax-free, as long as the funds are used to pay for college expenses like school tuition and books. Your 529 plan contributions are not tax-deductible, but these funds can grow tax-free while you save up for college.

How Can You Use a 529 Plan?

Unfortunately, not everyone can benefit from the tax advantages of a 529 plan. In order to avoid paying taxes and penalty fees, the funds must be used for educational expenses. For example, if you open a 529 plan for your child, but later your child decides to open a business rather than attending college, you will need to pay taxes and fees on your savings. If your child earns a scholarship that pays for tuition, you may be required to pay taxes as well.

Is It Safe to Rely on a 529 Plan?

Like most things in life, it is better to mitigate risk whenever possible. Putting all of your eggs in one basket can leave you vulnerable, so relying solely on a 529 plan may not be your best option. Thankfully, there are alternatives that can either replace or compliment a 529 plan.

Alternatives to a 529 Plan

Planning for college requires academic prowess, but it also requires careful financial management. Tuition and other costs associated with higher education are not cheap, so you will need to consider all of your options (not just a 529 plan) before developing a savings strategy. So, let’s take a look at some of the best additional college savings options:

Custodial Accounts

A custodial account, such as a UTMA (Uniform Transfers to Minors Act) or UGMA (Uniform Gifts to Minors Act) allows a parent or guardian to set up a financial account for the benefit of a child. These funds can be invested for a future date, and then administered to the beneficiary. These accounts work well because they have a predetermined recipient (your child), and are managed by a responsible party (you, the parent or guardian). Additionally, these accounts are highly flexible when it comes to asset usage. If your child needs to make a large investment earlier in life, these funds are accessible for their specific needs.

Permanent Life Insurance

There are several permanent life insurance tools available to minors who are saving for college. These generally offer more conservative returns, and can also be excluded from declarations for financial aid considerations. The downside is that they require more rigid funding schedules, whereas other types of accounts can be funded at any time, giving you much more flexibility. Still, these are a great alternative for the conservative investor with good cash flow who wants to put aside funds for financial aid purposes down the road.

Roth IRA

An older parent or guardian should consider allocating savings for their child’s education from their own Roth IRA. This way, the funds can grow tax-free, providing the optimal returns once the funds are withdrawn. However, the timing of this strategy is very important, as you will need to be at least 59.5 years old when the funds are needed, otherwise you won’t be able to take advantage of the tax-free withdrawals. A Roth IRA is very similar to a 529 plan, though a Roth IRA has fewer restrictions on usage.