The cost of college isn’t going down anytime soon. That means you need to start saving for your child’s college education today, if not yesterday. Two common ways to grow your college savings are 529 plans and brokerage accounts. So, which is most appropriate for your family? We at Advance Capital Management know that education is a primary financial goal for most families. But with financial aid dollars on the line and potential tax bills, choosing the right college planning strategy for your child can feel overwhelming. To help you decide which account makes sense, I’ve listed the differences between 529 plans and brokerage accounts for college savings. This article covers the following: A 529 plan is a state-sponsored tax-advantaged investment account for college and other higher-education expenses. The savings in a 529 account can be used for tuition, books, and other education-related expenses at most accredited colleges and universities, U.S. vocational-technical schools, and eligible foreign institutions. For several reasons, college savers are attracted to 529 plans, but the tax advantages may be the biggest draw. Your earnings can grow tax-deferred and some states allow you to deduct your contributions. Also, withdrawals for qualified higher-education expenses are tax-free. Brokerage accounts are a type of investment account that allows you to buy and sell stocks, bonds and other securities. Unlike college savings plans, there are no restrictions on when you can add or withdraw money from a brokerage account.What are 529 plans?
What are brokerage accounts?
This flexibility makes brokerage accounts a good option for families who want to save for their child's future but are still determining what the future holds. However, it's important to note that brokerage accounts do not offer the same tax benefits as college savings plans. When you sell investments in a brokerage account, you must pay capital gains taxes on any profits.
Now that you understand what 529 and brokerage accounts are, let’s dive into the differences between these accounts.
What are the tax benefits of each type of account?
529 plans: Earnings on investments in a 529 plan grow tax-deferred, and withdrawals are tax-free when used to pay for qualified education expenses. Qualified education expenses include tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution.
Brokerage accounts: Brokerage accounts are not tax-advantaged, but you may be able to defer or reduce taxes on investment gains depending on how you invest your money. For example, if you invest in stocks that pay dividends, you may be able to defer taxes on those dividends until you sell the stock. Generally, dividends from investments in brokerage accounts are taxed at ordinary income rates and capital gains tax rates apply when assets are sold at a profit.
How does a 529 vs brokerage account impact financial aid?
529 plans: 529 plans are more favorable on the FAFSA calculation (Free Application for Federal Student Aid). That’s because assets in a 529 plan are generally considered parental assets. Parental assets are assessed at a lower rate than student assets when determining financial aid eligibility.
Brokerage accounts: Regarding financial aid, asset assets in a brokerage account are treated differently depending on who owns the account. If the parents own the account, only 5.64% of the assets are counted towards the Expected Family Contribution (EFC). This is the same as the calculation for assets in a 529 plan owned by the parents.
However, if the child owns the account, 20% of the assets are counted towards the EFC. The federal financial aid formulas assume that 20% of the money in a child-owned account will be used to pay for college.
For example, if a parent has $100,000 in a brokerage account, only $5,640 will be counted towards the EFC. However, if a child has $100,000 in a brokerage account, $20,000 will be counted towards the EFC.
Learn more about ways to save for college -- and their impact on financial aid -- by downloading our free ebook:Saving for College: Financial Tools to Help Secure Your Student’s Future.
What are the investment options available in each type of account?
529 plans: 529 plans offer various investment options, including funds comprised of stocks and bonds with varying degrees of risk. The specific investment options available in a 529 plan vary from state to state.
Brokerage accounts: Brokerage accounts offer a wider variety of investment options than 529 plans. You can invest in individual stocks, bonds, mutual funds, exchange-traded funds (ETFs) and other securities.
What are the fees associated with each type of account?
529 plans: No fees are typically associated with opening or maintaining a 529 plan. However, fees may be associated with investing your money in a 529 plan. These fees can vary from plan to plan.
Brokerage accounts: There are typically fees associated with opening and maintaining a brokerage account. These fees can vary from brokerage to brokerage.
What are the withdrawal rules for a 529 vs brokerage account?
529 plans: Withdrawals from a 529 plan are tax-free when used to pay for qualified education expenses. However, if you withdraw money from a 529 plan for non-qualified expenses, you may have to pay income taxes on the earnings and a 10% penalty.
Brokerage accounts: There are no restrictions on when you can withdraw money from a brokerage account or what you use the funds for. However, you may have to pay income taxes on the earnings. Again, dividends from investments in brokerage accounts are taxed at ordinary income rates and capital gains tax rates apply when investments are sold at a gain.
What are the portability and beneficiary options for each type of account?
529 plans: 529 plans are portable, meaning you can transfer your account to another state if you move. You can also change the beneficiary of your 529 plan at any time.
Brokerage accounts: Brokerage accounts are not portable. However, you can transfer your assets from one brokerage to another.
What are the contribution limits for 529 and brokerage accounts?
529 plans: There are no yearly contribution limits to a 529 plan like there are with certain retirement accounts. However, each state has a different aggregate contribution limit for each 529 account. You also might trigger the gift tax if you contribute more than $17,000 to a 529 account or multiple accounts with the same beneficiary (2023).
Brokerage accounts: There are no contribution limits for brokerage accounts.
What if my child doesn’t go to college?
529 plans: You can change the beneficiary. As long as the new beneficiary is a family member, the money can be used for qualified education expenses without incurring income taxes or penalties. You can also cash out your 529, but you'll have to pay federal income taxes and a 10% penalty on the earnings.
Starting in 2024, beneficiaries of 529 accounts will have the option to roll over up to $35,000 over their lifetime to their Roth IRA. Rollovers are subject to Roth IRA annual contribution limits ($6,500 in 2023), and the 529 account must have been open for more than 15 years. Also, funds contributed to the 529 account within the five years preceding the rollover will not be eligible to roll over.
Brokerage accounts: If your child does not go to college, you can use the money for other purposes, such as a down payment on a house, a wedding or retirement.
Which type of account is right for my child's college savings needs?
Ultimately, the best type of account for your child's college savings needs depends on your circ*mstances and goals. If you are looking for a tax-advantaged way to save for college, a 529 plan may be a good option. A brokerage account may be a better choice if you are looking for more investment options and flexibility.
Start saving for college today
Choosing the right investment account for college savings can be a daunting task. As the pros and cons listed above show, there are many factors to consider, such as tax benefits, flexibility and your overall financial situation.
An excellent way to decide which type of account is right for you is to consult a financial adviser who can help you assess your individual needs and goals, and recommend the best investment strategy for your child's college savings. If you want a professional review of your finances and a comprehensive financial plan, schedule a free consultation with an Advance Capital Management financial adviser right now.
Patrick Cummins, CFP®
Patrick is a financial adviser whose priority is to help people achieve their financial and retirement goals. Working closely with clients, he incorporates all elements of their lives into personalized financial plans, including investment portfolio advice, tax strategies and saving for college. He is a CERTIFIED FINANCIAL PLANNER™ professional.
