529 Plans vs. Brokerage Accounts: Which is the Better Option for College Savings?
When planning for your child's higher education, choosing between a 529 plan and a brokerage account can often be overwhelming. Both options have their merits, but let's explore the advantages and drawbacks of each to help you make an informed decision.
What Are 529 Plans?
Created by Congress in 1996, 529 plans are state-sponsored investment vehicles designed to help families save for college. These plans offer several key benefits that make them a popular choice among parents:
Tax-Free Earnings and Withdrawals
One of the most significant advantages of a 529 plan is the tax-free earnings and withdrawals. The money in your 529 college savings account will not be subject to federal or state taxes, as long as it is used for qualified educational expenses. This means that every dollar you contribute grows and is available for your child's college education without reducing your taxable income.
Better Performance
529 plans typically offer higher returns compared to traditional savings accounts. On average, 529 plans deliver a 6% annual return, which is comparable to mutual funds. This higher performance helps your savings grow faster, providing more funds for your child's future education.
Least Impact on Financial Aid Eligibility
Savings in a 529 plan have the least impact on financial aid eligibility. While other investments like savings accounts or mutual funds can reduce your financial aid by up to 20%, a 529 plan only impacts aid by up to 5.64%. This means that if you save $10,000 in a 529 plan, your need-based financial aid eligibility would be reduced by only $564, whereas a $10,000 investment in a savings account could reduce your eligibility by $2,000.
What Are Brokerage Accounts?
Alternatively, a brokerage account allows you to choose how you invest the money. You can opt for dividend-paying stocks, bonds, or mutual funds. One of the main benefits of this approach is the flexibility it offers. Here's why some families might prefer a brokerage account:
Flexibility in Investments
With a brokerage account, you have the freedom to choose from a wide range of investment options. You can diversify your portfolio and manage it according to your risk tolerance. For instance, if you prefer dividend-paying stocks, you can opt for those, and the dividends create a steady cash flow that can be used for other purposes.
No String-Attached Withdrawals
Unlike a 529 plan, where the money must be used for qualified educational expenses, a brokerage account allows for more flexible withdrawals. While you will have to pay taxes on the dividends or capital gains, the money is not tied to any specific purpose. This allows you to use the funds for other purposes, such as paying for unexpected expenses.
Mutual Funds Within a 529 Plan
Another option to consider is the mutual funds within a 529 plan. These investment options are specifically designed to help college savings. They offer a mix of stocks, bonds, and other investment types, providing a balanced approach to growing your savings. Under the 2018 tax law changes, up to $10,000 of tuition costs and education expenses can be covered by these funds without impacting financial aid.
Conclusion
Both 529 plans and brokerage accounts have their advantages. 529 plans offer tax-free earnings, better performance, and minimal impact on financial aid eligibility. On the other hand, brokerage accounts provide flexibility in investments and more control over how the funds are used.
Ultimately, the best choice depends on your individual financial situation and goals. If you prefer a tax-efficient, low-risk approach with guaranteed educational use, a 529 plan might be the better option. However, if you want more flexibility and control over your investments, a brokerage account could be more suitable.
Consider consulting with a financial advisor to help you decide which path is best for your family's financial future.