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The Wall Street Journal

Oct. 18, 2017, 9:50 a.m. EDT

Saving for college? Here are some alternatives to the 529 account

The pros and cons of the different accounts

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By Chana R. Schoenberger


We again asked experts to help us answer readers’ questions on saving and paying for college.

As usually happens, most of the questions we received were about 529s, the tax-advantaged savings accounts for higher-education costs, which invest in mutual funds. But this time, we begin with a question about other kinds of accounts to save for college.

<STRONG>Aside from 529s, what are the upsides and downsides of alternative ways to pay for college?</STRONG>

While most financial experts agree that 529 plans are the most flexible and tax-advantaged vehicles, there are other ways of saving for college that could be useful.

It depends on what criteria are most important to a family’s situation.

For instance, in state-sponsored 529 accounts, investors (typically the parents) contribute after-tax money that grows tax-free and can be withdrawn later without federal taxes or penalties when used for qualified expenses like tuition, room and board, or a computer.

Some non-529 choices, by contrast, are more limited in terms of how much you can contribute, but can be less restrictive on what the money is used for.

“We recommend understanding the different features and benefits of the various education savings options, including contribution amounts, control of decision-making and ownership, tax considerations, flexibility with unused balances and financial-aid considerations,” says Danae Domian, a principal at brokerage firm Edward Jones.

Here are some ways to save for college, other than 529 plans:

• Coverdell education savings accounts  are more flexible than 529s in that they can be used for K-12 schooling, as well as higher education, says Rachel Ramos, a product manager for the American Funds 529 plan, CollegeAmerica. But they have income limitations and restrict contribution amounts—up to $2,000 a year from all contributors for a single beneficiary. Also, contributions aren’t allowed after the beneficiary turns 18.

The Coverdell account custodian—usually a parent—controls the account, and the beneficiary may take control at the age of majority (in most places, that’s 18), depending on the plan. Earnings grow tax-free, and there’s no federal tax when you take out money for qualified educational expenses. The account must be closed before the beneficiary turns 30. The money can be moved to a 529 for the same beneficiary, a 529 or Coverdell for a relative, or a regular brokerage account, in which case taxes and perhaps penalties are likely to be owed, unless the beneficiary has special needs.

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• Custodial accounts like UGMAs and UTMAs (Uniform Gifts to Minors Act and Uniform Transfers to Minors Act, respectively) don’t have tax benefits that compare with 529s, and the beneficiary becomes the account owner automatically at the age of majority, Ramos says. For gift-tax reporting purposes, individuals can contribute $14,000 per beneficiary a year. Because these accounts belong to the student, they may be counted as student-owned assets for financial-aid purposes, which can have a negative effect on aid eligibility.

Savers can also set up a custodial version of a 529, in which the beneficiary takes control upon reaching legal age, according to Edward Jones. Each contribution is an irrevocable gift, and so is a tax benefit for the contributor. But once the beneficiary reaches legal age, the custodian no longer has control over what the beneficiary does with the money—including requesting a nonqualified transfer out of the account, which would be taxable and may not go toward education.

• Roth IRAs  are designed to be retirement-savings vehicles, which means that if the child doesn’t go to college, the account owner can have the flexibility of using the money for retirement. Savers can contribute up to $5,500 a year (or $6,500 if over age 50) to a Roth as long as their incomes are within certain limits, and there is no penalty for withdrawals before age 59½ if the money is used for qualified higher-education expenses. However, the account owner may have to pay income tax on the earnings portion of any withdrawal. Note that the entire withdrawal—principal and earnings—may be considered income for financial-aid purposes and will likely affect your aid application for the following year.

• Series EE and I savings bonds have some limited benefits for educational savings. Anyone can buy these bonds, up to $10,000 a year per bond type, and financial-aid forms count these bonds as the asset of the bond owner, who must be the student’s parent, or an adult student of at least age 24.

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