Saving for your child’s future doesn’t always mean using a 529 plan. Learn how a brokerage account can provide flexibility and control for college savings, future home purchases, business funding and other family goals.
Saving for your child’s education? A 529 college savings plan can help families invest for future education expenses while offering tax advantages and flexibility. Learn how 529 plans work, who can own them, investment options, what happens to unused funds and more.
By Plumb Financial
What is the best account to save for your child’s future college education?
It’s a great question—and one I hear often from parents and grandparents.
With new changes and increased attention around children’s savings accounts, I’ve also seen a lot of questions on social media about which accounts families should be using to save for education.
One of the most established options is the 529 college savings plan.
So, let’s talk about how 529 plans work, who can own them, how you can invest the money, what happens when you need to use the funds, and what you can do if your child doesn’t use all of the money.
A 529 plan is a tax-advantaged account designed to help families save for qualified education expenses.
529 plans were originally created primarily for college savings, but their potential uses have expanded.
Depending on the circumstances and applicable rules, 529 funds can be used for qualified expenses related to:
That means a 529 plan doesn’t necessarily have to be something you open when your child is heading off to college.
It can potentially be part of a much longer education funding strategy—from elementary school through higher education.
One of the things I like about 529 plans is that the account owner maintains control of the account.
Typically, a parent or grandparent is the account owner, while the child is named as the beneficiary.
The owner controls the account and determines how the money is invested and used.
And importantly, the beneficiary can generally be changed.
Let’s say you have been saving for your child for years, but that child receives a scholarship, joins the military and receives education benefits, or simply doesn’t need all of the money you’ve saved.
You may have options for using those funds for another eligible family member rather than simply letting the money sit unused.
That flexibility can be a valuable part of long-term family financial planning.
If you have multiple children, I generally prefer thinking about each child’s education savings separately.
For example, imagine you have three children.
Instead of treating your savings as one large education account, consider establishing a separate 529 account for each beneficiary.
Why?
Because each child has a different timeline.
A 5-year-old has a much longer investment horizon than a 15-year-old. That difference can affect how aggressively you invest the money and how much market risk you may want to take.
When each child has an individual account, you can create a savings and investment strategy based on that child’s timeline and education goals.
Contributions to a 529 plan are generally treated as gifts for federal gift-tax purposes.
As discussed in my video, the annual gifting amount is an important consideration when determining how much you can contribute.
There is also a strategy that may allow you to front-load five years of annual gift-tax exclusions into a 529 account, subject to the applicable rules and elections.
For families who receive an inheritance or have a significant amount of money they want to dedicate toward a child’s education, this can potentially allow those dollars to begin working toward the family’s education goal sooner.
The key is understanding the rules before making a large contribution.
Opening a 529 account is only the first step.
You also need to decide how the money inside the account should be invested.
There are generally several approaches.
For families looking for a relatively simple approach, a target-date investment option can be attractive.
The investment strategy is generally designed around the year the money is expected to be needed.
For example, if your child is expected to start college around 2030, you might select an investment option designed around that time frame.
As the target date gets closer, the investment allocation generally becomes more conservative.
That can make sense because you don’t want to take the same level of investment risk when your child is 18 and tuition is coming due as you might when your child is 3.
Another option may be a diversified moderate portfolio that maintains a particular investment mix over time.
This can give the account owner more control than a target-date approach but also requires more attention.
Some plans also allow investors to select among specific investment options, such as mutual funds or ETFs.
You might decide how much to allocate to growth investments, international investments, bonds and other asset classes.
This approach provides more control but also requires more ongoing management.
The right investment strategy depends on your goals, timeline and comfort with investment risk.
One of the biggest advantages of a 529 plan is the potential for tax-deferred growth and tax-free withdrawals for qualified education expenses.
Contributions are made with after-tax dollars.
The money can then grow inside the account without creating annual federal income tax on the investment growth.
When money is withdrawn for qualified expenses, the earnings portion can generally be withdrawn tax-free under the applicable rules.
That’s an important distinction.
You aren’t receiving a federal income-tax deduction simply because you contributed money to a 529 plan. The potential tax advantage comes primarily from the tax treatment of investment growth and qualified withdrawals.
For Texas families, there’s another consideration.
Texas does not currently have an individual state income tax, so there isn’t a Texas state income-tax deduction for 529 contributions.
For someone living in a state with an applicable state income tax benefit, however, contributing to a 529 may provide an additional state tax advantage.
This is one of the questions parents ask all the time.
What happens if I save all of this money and my child gets a full scholarship?
You may have several options.
Depending on the circumstances, you may be able to:
The ability to change beneficiaries can make a 529 particularly useful for families who want to plan across multiple generations.
Money saved for one child doesn’t necessarily have to stop being useful if that child doesn’t need it.
One of the more interesting developments in 529 planning is the ability, under certain circumstances, to move unused 529 funds into a Roth IRA for the beneficiary.
The transcript highlights a $35,000 lifetime limit for this type of rollover.
However, there are important eligibility requirements and limitations surrounding these rollovers, so this is not something I would recommend doing without first reviewing the specific account and beneficiary circumstances.
The big-picture idea is exciting:
Instead of unused education savings simply becoming a problem, certain unused funds may potentially become part of the beneficiary’s long-term retirement savings strategy.
That creates another opportunity for education savings to become wealth-building savings.
This is where you need to be careful.
Suppose you have $50,000 sitting in a 529 and your child wants to use some of it toward a down payment on a home.
A home down payment is not generally a qualified education expense.
You can potentially take the money out, but the tax consequences may be different from a qualified withdrawal.
The earnings portion of a nonqualified withdrawal can generally be subject to income tax and potentially an additional penalty.
And there’s another important consideration:
Who owns the account?
If the parent owns the account and makes a nonqualified withdrawal, the tax consequences generally belong to the account owner.
Depending on the family’s circumstances, changing ownership or considering another strategy may be worth evaluating before taking the money out.
This is one of those situations where I strongly recommend talking with your financial planner and tax professional before making the withdrawal.
When I think about 529 plans, I don’t just think about paying a college tuition bill.
I think about family wealth planning.
A 529 account can potentially help parents and grandparents:
The best account isn’t necessarily the one with the most features.
It’s the one that fits your family’s goals.
Maybe.
The better question is:
What are you trying to accomplish with the money?
Are you trying to pay for all of your child’s education?
Half of it?
Private school?
College?
Trade school?
Are grandparents contributing?
Could multiple children benefit from the savings?
What happens if your child receives a scholarship?
How much investment risk are you comfortable taking?
And how does education funding fit into the rest of your financial plan?
These are the questions that should come before choosing the account.
At Plumb Financial, we believe the plan comes first and the financial tools come second.
A 529 may be an excellent tool—but it should be part of a larger strategy designed around your family’s goals.
If you’re wondering whether a 529 college savings plan is right for your family, let’s talk.
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