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College saving plans that are often underutilized

Shelly  Gigante

Posted on May 09, 2023

Shelly Gigante specializes in personal finance issues. Her work has appeared in a variety of publications and news websites.
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Outline the difference between 529 prepaid tuition plans and 529 college savings plans.

Describe the pros and cons of saving for college in a 529 college savings plan. 

Note some alternatives to a 529, including Coverdell ESAs, IRAs, and UGMAs. 

Most families who are socking money away for their children’s college tuition don’t take advantage of tax-friendly savings tools, like 529 college savings plans, that could potentially supercharge their savings.

Results from the latest MassMutual College Savings Study reveal that just 28 percent of families who expect their kids to attend an institute of higher learning plan to use a tax-deferred college savings program, such as a 529 plan or Coverdell account, to save.

In fact, nearly half (46 percent) of families are banking on a college-sponsored scholarship as their top strategy for paying for college, while 41 percent plan to use federal student aid programs, such as Pell Grants. (Pell Grants are federal subsidies that are typically only awarded to undergraduate students who demonstrate financial need. Unlike a loan, grants and scholarships do not need to be repaid.)

Other research similarly reveals families are far more likely to use traditional savings accounts, which offer no tax benefit and miniscule interest rates, rather than 529s. (Calculator: How much do I need to save for college?)

Sallie Mae, the nation’s leading provider of education funding, reports that 63 percent of tuition-saving parents used current income to pay for college, 37 percent use “other savings and investments,” and 33 percent used 529 college savings plans.1 Roughly 18 percent use retirement savings withdrawals (Respondents were permitted to select more than one answer.)

While any money their parents set aside can help college-bound kids minimize the debt they will incur upon graduation, savings accounts with tax-friendly benefits, such as 529 plans and Coverdell Education Savings Accounts, can potentially deliver a bigger bang for the buck, said Ellen Roberts, a Sallie Mae spokesperson.

“Sallie Mae highly recommends the use of 529 plans,” she said. “In fact, they’re an important part of our 1-2-3 approach to saving for college: first, open a savings account; second, set a goal and make deposits regularly; and third, explore tax-advantaged options such as 529 college savings plans.” (Learn more: College savings)

The tax-friendly 529 college savings plan

Contributions to a 529 account are made on an after-tax basis, and thus yield no immediate tax deduction, but the earnings grow federal tax free if used for qualified education expenses such as tuition, fees, books, and room and board. Individual states may also offer a full or partial tax deduction for residents who invest in the 529 college savings plan operated by their state. (Your choice of 529 plan has no impact on where your child can attend college, which is a common misconception. You can open a 529 account in your home state of, say, Virginia, and your child can use it to pay for tuition at a qualified school in Vermont.)

The IRS also now permits account owners to use their 529 plans to pay for computer technology and related equipment (including software and even Internet access) if they are used by the beneficiary during the years they are enrolled at a qualified educational institution.

The most recent data from the College Savings Plan Network, a resource for state-operated college savings programs, reveal 529 plans nationally have $411 billion in assets under management, with an average account balance of $25,630.

529 programs come in two flavors: Prepaid tuition plans and college savings plans. The prepaid tuition plans, which are less popular, allow parents and others to purchase "units" of tuition, or credits, for future use by a designated beneficiary based on today’s cost of tuition – effectively enabling them to lock in tomorrow’s tuition price today. (Learn mored: Prepaid versus savings 529s)

By contrast, contributions to a college savings plan are invested in stocks, mutual funds, and bonds. Many, but not all, 529 college savings plans automatically adjust their asset mix to become more conservative as the beneficiary approaches college age and the emphasis shifts to asset preservation rather than growth. Because their return is tied to market performance, 529 college savings plans are subject to risk. There are no guarantees your investment will grow.

Also, any earnings not used for qualified education costs are generally subject to a 10 percent withdrawal penalty, although some exceptions do apply. Account owners, for example, would typically not be penalized if the beneficiary dies or becomes disabled, receives a scholarship, or decides to attend a U.S. military academy. You would still, however, owe income tax on the earnings.

“We absolutely recommend 529s,” said Christopher Stappas, a financial professional and principal with Summit Financial Resources in Parsippany, New Jersey. “The tax benefits are good, but one of the ancillary benefits that a lot of people overlook is that they help families set up a structured, disciplined strategy for saving. That’s the way you create and grow wealth. When you automate your savings, all of a sudden you get this statement at the end of the year and you’ve saved $20,000 and you didn’t even miss it.”

The downsides to 529 accounts may explain why some families stick with more traditional savings tools.

“Some families choose not to invest in 529s because they either aren’t sure if their child will choose to attend college, or because they don’t get an immediate tax deduction for their contribution, as they would with a tax- deductible IRA contribution, so they just choose not to,” said Kathryn Hauer, a financial professional with Wilson David Investment Advisors in Aiken, South Carolina, and author of “ Financial Advice for Blue Collar America.”

Also, she said, they may not be positioned financially to reap the potential rewards of compounded growth. “You get the biggest benefit from a 529 by starting young and investing when the child is little, but it’s hard to look at a two-year-old and think about that child going to college, especially when there are so many other immediate costs to contend with.”

Jim DiUlio, vice-chair of the College Savings Plans Network and director of the 529 program operated by Wisconsin, also attributes the minimal participation in 529s nationally to lack of knowledge about the tax benefits.

“Prepaid tuition plans have only been around about 20 years and 529 college savings plans for even less so a lot of the general public, and even some financial professionals, are still really not aware of the program benefits,” DiUlio said. “I think it’ll be a no-brainer for the next generation, the young adults who actually went to school using 529s, when they start their own families.” (Learn more: Getting the most out of a 529)

Sallie Mae research supports that theory: Among parents saving for college but not using a 529 plan, more than half are not aware of them (51 percent never heard of them and 9 percent are not sure if they have).2

Among college-savers who are aware of 529 plans, it found, 27 percent say they don’t use 529s because they don’t know enough about them, 18 percent prefer a different method, and another 8 percent aren’t sure why they don’t use one.

To counter fears about 529 penalties, DiUlio said account owners do have options if their child decides not to pursue higher education. For example, you can pass those savings on to any siblings, nieces, or nephews. “Almost everyone who comes for Thanksgiving dinner would be eligible,” he said. (Learn more: Alternatives for 529 college savings)

Starting in 2024, 529 account holders will be able to transfer up to a lifetime limit of $35,000 to a Roth IRA for a beneficiary (i.e. the student). (Related: New in 2024: 529 transfers to a Roth IRA)

Or, the account owner can simply leave the funds in the account and use them if the original beneficiary decides to attend college down the road, or use their savings to pay for their own education should they decide to take college credits or change careers. “That’s something most people don’t think about,” he said. “People are constantly reinventing themselves and seeking different degrees.”


Alternative college savings plan options

529 college savings plans, of course, are not the only game in town for families looking to finance qualified education costs.

Alternative college savings tools include:

  • Coverdell ESAs, which are potentially available to those with modified adjusted gross income of less than $110,000 ($220,000 in the case of a joint return). As with a 529, contributions are not deductible, but amounts deposited in the account for beneficiaries grow tax free until distributed. The limit to how much you can save, however, is $2,000 per beneficiary per year, no matter how many accounts have been established. By comparison, contribution limits for 529 plans are set by the state, but can be as high as $550,000 (Missouri).3 (Taxpayers may contribute up to $17,000 per year [$34,000 per couple]) to a 529 without triggering the gift tax, as of 2023. They can also potentially opt for a special election that allows them to treat a single contribution of $85,000 [$170,000 for married couples] as if it were made over a 5-year period, and avoid paying the gift tax.
  • Uniform Gift to Minors Act (UGMA) and Uniformed Transfer to Minors (UTMA) accounts, also known as custodial accounts, are yet another savings tool. Donors (parents, grandparents and others) may open an UGMA or UTMA account in a beneficiary’s name. Any income it generates must be reported on the child’s tax return and is taxed at the child’s rate. Note, too, that the donor cannot impose conditions on the account. When the beneficiary is eligible to receive the funds, he or she may use the money for any purpose he or she likes — which may not necessarily be a college degree. Financial aid website FinAid adds, too, that money from an UGMA or UTMA custodial account counts as part of the student’s assets for the purposes of determining financial aid. Thus, it can potentially deal a blow to their eligibility for tuition assistance.
  • Individual retirement accounts, IRAs, may also provide a port in the storm for families struggling to save for college tuition. The IRS allows savers to tap their IRA penalty free to pay for tuition, fees, books, supplies, and equipment required for college before age 59-1/2. Normally, IRA owners who take early distributions from their account are subject to a 10 percent penalty on the amount withdrawn. You may still owe income tax on at least part of the amount distributed. Financial professionals caution, however, that parents should never tap their own retirement savings unless they have already met their nest-egg goal. Students can always get a scholarship or take on loans, but no such help exists for meeting living expenses during retirement.
  • Permanent life insurance, such as whole life insurance, which accumulates cash value, may potentially be used tax free to help pay for tuition. Unlike money that accumulates in a 529 plan, which is considered a parental asset for purposes of determining federal financial aid eligibility, the cash value in a life insurance plan is sheltered from the financial-aid-need analysis. Access to cash value through borrowing or partial surrenders, however, will reduce the policy’s cash value and increase the chance the policy will lapse. If this happens, it may result in a tax liability.

For some college savers, a combination of several savings tools might make sense.

Danijel Velicki, for example, a financial professional with Opus Group of Virginia in Virginia Beach, Virginia, said he intends to have his children take on student loans, which he will help repay (only if they graduate) with the savings he is accumulating in taxable brokerage accounts and his cash value life insurance policy. He is also saving money in a 529 to help cover the costs of books, fees, and other qualified expenses along the way.

“College saving doesn’t just have to be 529s,” he said. “We all know the markets go down, so this way I’m diversified. If the stock market is down when my kids go to college, I can use my cash value and leave my invested assets alone until the market recovers.”

Families should work closely with a financial professional to determine a savings strategy that works best for them.

Discover more from MassMutual…

A primer on college financial aid

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Need a financial professional? Let us know

This article was originally published in March, 2017. It has been updated.


1 Sallie Mae, “How America Pays for College," 2022.

2 Sallie Mae, “How America Saves for College,” 2018.

3 Saving for College, “Maximum contributions,” Jan. 25, 2023.

The information provided is not written or intended as specific tax or legal advice. MassMutual, its employees and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel. Opinions expressed by those interviewed are their own and do not necessarily represent the views of Massachusetts Mutual Life Insurance Company.