How To Choose The Right Account To Save For College
- Kirk Reagan
- Feb 11
- 8 min read
Updated: Feb 12
Choosing the right account to save for college has never been more important. Tuition continues to rise faster than inflation and the expenses around room and board are following the same trend. Families feel the pressure long before their son or daughter fills out the first application. What often gets overlooked is that the account you choose to save in matters just as much as the amount you save. It affects your taxes, your long-term flexibility, and even your financial aid eligibility.
Choosing the right account to save for college has never been more important. Tuition continues to rise faster than inflation and the expenses around room and board are following the same trend. Families feel the pressure long before their son or daughter fills out the first application. What often gets overlooked is that the account you choose to save in matters just as much as the amount you save. It affects your taxes, your long-term flexibility, and even your financial aid eligibility.
When people ask which account is “best,” the answer is that it depends on what a family values most. There are meaningful differences between a parent owned taxable account, a custodial account such as a UTMA or UGMA, and a 529 plan. Each one works well in the right situation. Each one can be a problem in the wrong one. I will help explain which one may be right for you and your situation.
A parent owned taxable account is the simplest option and the most flexible. You can use the money whenever you want and for any purpose. If plans change and college is not the path your child takes, nothing is locked in. Long term capital gains rates also make this structure more efficient than people expect. The tradeoff is that there are no special educational tax benefits and no tax deferral. It also counts as a parent asset on the FAFSA, but at the lower 5.6 percent rate. Flexibility is where this account shines, and sometimes that is exactly what a family needs. There are no rules at all, so if you decide later to not use it for education, you are allowed to use it on anything you desire with no additional rules or fees other than taxes.
Custodial accounts like UTMAs or UGMAs bring a different set of considerations. They can be used for any expense that benefits the child, not just college, which can be helpful if a young adult chooses trade school, military service, entrepreneurship, or anything outside of the standard college route. Some of the growth is taxed at the child’s rate, at least up to certain limits, and that can help. The challenge is that these accounts eventually belong entirely to the child. Once they reach the age of majority, they control the funds and can use them however they want. HOWEVER, FAFSA treats these as student assets and assesses them at about 20 percent, which is a significant impact. UTMAs and UGMAs can be useful tools, but families should be very intentional before relying on them for college if they plan to try for financial aid.
For most families, the 529 plan ends up being the central piece of their strategy. The tax benefits are hard to ignore. Contributions grow tax deferred and come out tax free if used for qualified education expenses. Those expenses include tuition, fees, books, supplies, certain equipment, room and board for at least half-time students, and even some K through 12 tuition and student loan repayments. States vary in how they reward contributions, so it is important to check whether your state offers a deduction or credit. When used properly, a 529 plan can stretch your education dollars farther than any other option. However, you do give up some investment flexibility and, if the funds are used for a non-qualified purpose, the earnings face income tax and a penalty. Even so, these plans remain one of the most efficient ways to prepare for the rising cost of college. They also count as a parent asset on the FAFSA (only if owned by the parent), not a student asset, which reduces the financial aid impact.
There are planning opportunities inside the 529 structure that many families overlook. One example involves coordinating 529 withdrawals with the American Opportunity Tax Credit. The rules prohibit using the same expenses for both benefits, so the most effective approach is to pay at least four thousand dollars of tuition out of pocket each year to qualify for the credit and then use the 529 for the remaining costs. Over four years, the tax savings add up.
Another newer opportunity is the ability to convert certain unused 529 funds to a Roth IRA for the beneficiary. The rules are strict and the account must have been open for 15 years, but for families who start early, this can turn leftover college savings into a meaningful head start on retirement. And if your child is under age 7, well consider this your heads up!
If financial aid is part of the equation, the ownership of each account matters. Parent owned 529s and taxable accounts are assessed at the lower parent rate. Custodial accounts are assessed at the much higher student rate. Grandparent owned 529s used to create complications because distributions counted as income to the student two years later. Recent rule changes have removed most of those issues, which opens the door to better multi-generational planning.
In the end, the right choice depends on what you value most. If you want the best long term tax treatment, the 529 is the strongest option. If flexibility is paramount, a taxable account has advantages. Custodial accounts can fit families who want to give a child broader access to funds, as long as they understand the implications for financial aid and control. Many families use more than one approach to balance these priorities.
The most important step is to choose a structure and begin. The earlier you start, the more time you have for growth and compounding to work in your favor. Once the account is open, tools and calculators can help determine the savings targets needed to meet your goals. And if you want help working through the numbers or building a coordinated plan, I am always glad to walk through the details.
When people ask which account is “best,” the answer is that it depends on what a family values most. There are meaningful differences between a parent owned taxable account, a custodial account such as a UTMA or UGMA, and a 529 plan. Each one works well in the right situation. Each one can be a problem in the wrong one. I will help explain which one may be right for you and your situation.
A parent owned taxable account is the simplest option and the most flexible. You can use the money whenever you want and for any purpose. If plans change and college is not the path your child takes, nothing is locked in. Long term capital gains rates also make this structure more efficient than people expect. The tradeoff is that there are no special educational tax benefits and no tax deferral. It also counts as a parent asset on the FAFSA, but at the lower 5.6 percent rate. Flexibility is where this account shines, and sometimes that is exactly what a family needs. There are no rules at all, so if you decide later to not use it for education, you are allowed to use it on anything you desire with no additional rules or fees other than taxes.
Custodial accounts like UTMAs or UGMAs bring a different set of considerations. They can be used for any expense that benefits the child, not just college, which can be helpful if a young adult chooses trade school, military service, entrepreneurship, or anything outside of the standard college route. Some of the growth is taxed at the child’s rate, at least up to certain limits, and that can help. The challenge is that these accounts eventually belong entirely to the child. Once they reach the age of majority, they control the funds and can use them however they want. HOWEVER, FAFSA treats these as student assets and assesses them at about 20 percent, which is a significant impact. UTMAs and UGMAs can be useful tools, but families should be very intentional before relying on them for college if they plan to try for financial aid.
For most families, the 529 plan ends up being the central piece of their strategy. The tax benefits are hard to ignore. Contributions grow tax deferred and come out tax free if used for qualified education expenses. Those expenses include tuition, fees, books, supplies, certain equipment, room and board for at least half-time students, and even some K through 12 tuition and student loan repayments. States vary in how they reward contributions, so it is important to check whether your state offers a deduction or credit. When used properly, a 529 plan can stretch your education dollars farther than any other option. However, you do give up some investment flexibility and, if the funds are used for a non-qualified purpose, the earnings face income tax and a penalty. Even so, these plans remain one of the most efficient ways to prepare for the rising cost of college. They also count as a parent asset on the FAFSA (only if owned by the parent), not a student asset, which reduces the financial aid impact.
There are planning opportunities inside the 529 structure that many families overlook. One example involves coordinating 529 withdrawals with the American Opportunity Tax Credit. The rules prohibit using the same expenses for both benefits, so the most effective approach is to pay at least four thousand dollars of tuition out of pocket each year to qualify for the credit and then use the 529 for the remaining costs. Over four years, the tax savings add up.
Another newer opportunity is the ability to convert certain unused 529 funds to a Roth IRA for the beneficiary. The rules are strict and the account must have been open for 15 years, but for families who start early, this can turn leftover college savings into a meaningful head start on retirement. And if your child is under age 7, well consider this your heads up!
If financial aid is part of the equation, the ownership of each account matters. Parent owned 529s and taxable accounts are assessed at the lower parent rate. Custodial accounts are assessed at the much higher student rate. Grandparent owned 529s used to create complications because distributions counted as income to the student two years later. Recent rule changes have removed most of those issues, which opens the door to better multi-generational planning.
In the end, the right choice depends on what you value most. If you want the best long term tax treatment, the 529 is the strongest option. If flexibility is paramount, a taxable account has advantages. Custodial accounts can fit families who want to give a child broader access to funds, as long as they understand the implications for financial aid and control. Many families use more than one approach to balance these priorities.
The most important step is to choose a structure and begin. The earlier you start, the more time you have for growth and compounding to work in your favor. Once the account is open, tools and calculators can help determine the savings targets needed to meet your goals. And if you want help working through the numbers or building a coordinated plan, I am always glad to walk through the details.
Disclaimer: This article is for educational purposes only and is not personal financial advice. Every situation is unique. Consult a qualified professional before making decisions about your own planning.
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