When planning for your child’s future, 529 plans and taxable brokerage accounts offer two effective savings options. Both have distinct advantages, and the best choice depends on your family’s priorities, financial goals, and tax strategies. In this blog post, we’ll explore the key differences and considerations, along with recent updates to 529 plans that make them even more appealing.
I work with many young families and plan for the future of my own children with these two accounts. Make sure that you join the K-12 Planning newsletter to get notification of new blog posts, up-to-date information on student loans, and other Financial Planning focused ideas:
What Is a 529 Plan?
A 529 plan is a tax-advantaged savings account for education expenses, offering significant benefits for families who prioritize education funding.
Key Benefits:
Tax Advantages: Contributions grow tax-free, and withdrawals for qualified education expenses, such as tuition, are also tax-free. Some states offer additional tax benefits for contributions. Check your state’s specific rules here.
High Contribution Limits: Unlike other education savings tools, 529 plans allow for substantial contributions.
Roth IRA Conversion: Starting in 2024, unused 529 funds can be rolled over into a Roth IRA for the beneficiary after the account has been open for at least 15 years, subject to certain limits (more on this below).
Financial Aid-Friendly: Assets in a 529 plan are considered parental assets and have a smaller impact on financial aid than assets held directly by the student.
Drawbacks:
Restricted Use: Non-qualified withdrawals are subject to taxes and a 10% penalty on earnings.
Investment Limitations: Plans offer a selection of pre-designed portfolios rather than full investment flexibility.
What Is a Taxable Brokerage Account?
A taxable brokerage account is a flexible investment account that can be used for any purpose, including education expenses, a down-payment for a house, or a car.
Key Benefits:
Unlimited Flexibility: Funds can be used for any purpose, from education to a wedding or home purchase.
No Contribution Limits: Unlike 529 plans, there are no caps on how much you can invest annually.
Diverse Investment Choices: You have full control over your investment strategy and can select individual stocks, bonds, mutual funds, or ETFs.
Tax Benefits for Long-Term Gains: Gains on investments held for over a year are taxed at lower long-term capital gains rates.
Drawbacks:
Taxable Growth: You’ll owe taxes annually on dividends and realized gains.
Higher Financial Aid Impact: Taxable accounts are treated as parental assets but can still reduce financial aid eligibility more than a 529 plan.
New Opportunity: Roth IRA Conversions for Unused 529 Funds
A game-changing update for 529 plans is the ability to convert unused funds into a Roth IRA for the beneficiary starting in 2024. Here are the key details:
The account must have been open for at least 15 years.
Contributions made within the last five years are not eligible for conversion.
Annual conversions are subject to the IRA contribution limit, and the lifetime rollover cap is $35,000.
This new feature mitigates concerns about overfunding a 529 plan, as any leftover funds can still benefit your child’s future by kickstarting their retirement savings.
When Should You Use a 529 Plan?
A 529 plan is ideal if:
You are confident the funds will be used for education expenses.
Your state offers tax benefits for contributions—check your state’s rules.
You value the new Roth IRA conversion feature for added flexibility.
When Should You Use a Taxable Brokerage Account?
A taxable brokerage account is better suited if:
You want complete flexibility in how and when the funds are used.
You prefer broader investment options.
You are using other tools for tax-advantaged savings and prioritize diversification.
Blending Both Options
For many families, a balanced approach works best:
Use a 529 plan to cover predictable education expenses like tuition, maximizing any state tax benefits.
Invest additional funds in a taxable brokerage account to maintain flexibility for unexpected needs or expenses not covered by a 529 plan.
Finding the Balance
What will education look like by the time your child finishes high school?
What if he/she chooses not to go to college?
This is why I love options! I like to use the 529 plan so that if a child goes to college or another program that requires tuition, we have that covered. I just don't want to overfund it! I also love the flexibility of the brokerage account. I believe that these two used in tandem can create a great balance between making sure that you have some coverage for your children's future while also making sure that you have the flexibility you want along the way. You never know what the future will bring!
Final Thoughts
529 plans and taxable brokerage accounts can both play vital roles in a comprehensive education savings strategy. The decision comes down to how much flexibility you need, the tax benefits available in your state, and your confidence in education-specific savings.
By leveraging the strengths of both tools, you can create a robust plan that supports your child’s education and future goals. If you haven't already, make sure you subscribe to the K-12 Planning newsletter for weekly emails pertaining to educators and your finances!
David Gourley, CSLP® is the Founder and lead Financial Planner at K-12 Planning, an independent financial planning firm specializing in finance for teachers. He served for eight years as a high school mathematics teacher before transitioning into the financial services industry. He started K-12 Planning in 2024 and his passion for serving as a fiduciary for teachers and a student loan planning expert runs deep, as his wife and several other family members have served as educators for years.
Comentarios