Are There Better Options Than a 529 Plan?

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Since their introduction in 1996, 529 savings plans have proven to be a popular way to save for college, accumulating more than $110 billion in assets. Learn more about 529 plans here.

Although a 529 plan may be a good choice for many individuals and families, be sure to consider some alternatives when developing a college savings strategy.

529 Plan Alternatives

A Coverdell education savings account (ESA, formerly called an education IRA), offers the same tax deferral and tax-free distribution advantages of a 529 account.

Pluses:

  • You may also use a Coverdell ESA to cover qualified elementary and secondary school expenses.
  • You can transfer the account to another eligible beneficiary if your child decides not to go to college.
  • You have a much broader range of investments available to you than you would with a 529 plan.

Minuses:

  • There is an annual contribution limit of just $2,000 for any one beneficiary. That may not be enough to accumulate a sufficient college fund.
  • You must meet income eligibility limits to be able to contribute to a Coverdell ESA. Currently, your modified adjusted gross income must be less than $110,000 (single filer) or $220,000 (joint filers) to be eligible to contribute.

Custodial accounts, like a Uniform Transfer to Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA) account, can be used for any expense benefitting a minor, including education.

Pluses:

  • You can gift up to $14,000 ($28,000 if your spouse joins you in the gift) in 2013* without triggering estate taxes.
  • Up to $950 in annual unearned income may be tax free, and the next $950 taxed at the child's presumably lower rate, for dependent children under age 19 (age 24 for dependent students).

Minuses:

  • Once the child reaches the age of majority (18 in California, unless the account specifically mentions a later age, up to 21), the account is his or hers without limitation on how it can be spent.
  • Because financial aid formulas generally target a greater percentage of a child's assets than the parents', an UTMA or UGMA may negatively affect eligibility for financial aid.

You can save on your own through a taxable account.

Pluses:

  • Complete freedom to choose the investments you wish, and the account belongs to you with no strings attached.
  • There are no income restrictions and no restrictions on the age or relationship of the beneficiary.
  • Parents' personal savings generally do not have as large an impact on a child's financial aid eligibility, since most formulas consider only about 5% of the parents' assets available for education costs, compared with about 20% of the child's assets.

Minuses:

  • There are no education tax breaks. You will pay taxes on any earnings in the account. However, if you have long-term capital gains, earnings will be subject to the more favorable long-term capital gains rate instead of ordinary income taxes.

A Big Step

College costs will likely rank second only to a home purchase in major lifetime expenses, so it pays to consider all your options.

* Note: Annual exclusion is indexed to inflation and may be adjusted in future years.
Note that California Teachers Association does not give tax or legal advice. Consult your tax advisor or attorney for information specific to your situation.