College savings jar full of coins
Funding college education is one of the most important financial goals you can have. While reports differ as to whether costs are rising or falling in recent years, college tuition is still a significant expense, even with financial aid and scholarships. Whether you are a parent, guardian, or student, understanding and comparing different savings options can help you plan better. This article explores six common college savings accounts in the United States.
529 College Savings Plan
Named after Section 529 of the Internal Revenue Code, these plans are sponsored by states, state agencies, or educational institutions. A 529 plan is an investment account that features tax advantages and potentially other incentives that make it easier to save for college or other educational expenses. Most 529 plans have access to a range of investment portfolios, including age-based options that automatically adjust risk as the beneficiary approaches college age.
While states offer different perks and benefits for contributing to 529 plans, a common feature is that your earnings grow tax-free at the federal level. Withdrawals used for qualified education expenses, such as tuition, room and board, books, and other mandatory expenses, are also tax-free. There is no federal contribution limit for 529 college savings plans, but each state sets their own, ranging from $235,000 to more than $500,000 per beneficiary. For example, you can contribute up to $529,000 in California, $350,000 in Kentucky, and $269,000 in North Dakota. Incidentally, Wyoming is the only state that does not offer a 529 plan.
Funds can be also transferred between beneficiaries if one child doesn’t use all the money. The Tax Cuts and Jobs Act of 2017 has also expanded the use of 529 funds to include up to $10,000 per year for K–12 tuition and a lifetime limit of $10,000 for student loan repayment. As such, 529 plans are ideal if you are seeking a long-term, tax-efficient vehicle for college savings. Their high contribution limits and broad eligibility make them accessible to most households.
529 Prepaid Tuition Plan
This is another type of 529 plan administered by state governments. It allows you to purchase future college tuition at current prices, helping you lock in costs and better plan your finances. Unlike 529 college savings, prepaid tuition plans are considered conservative since they do not typically have an investment component. Nonetheless, they are reliable vehicles that can shield you from rising college costs.
You must note that prepaid plans cover only tuition and mandatory fees, not room and board or other expenses. They are also limited to public in-state colleges and universities, meaning if a beneficiary chooses to attend a private or out-of-state institution, the plan may pay only a portion of the tuition equivalent, which could significantly reduce its value. Lastly, many prepaid plans have residency requirements. Hence, these plans are best suited if you are confident you or your child will attend an in-state public institution.
Coverdell Education Savings Account
This is a special savings account that can be used for both K–12 and higher education expenses. These accounts are not state-sponsored but are instead established through financial institutions. A Coverdell ESA allows tax-free growth and tax-free withdrawals for education expenses. However, unlike 529 plans, the range of qualified expenses is broader and includes other items like tutoring, school supplies, and uniforms.
A major drawback of the ESA is its relatively low annual contribution limit, just up to $2,000 per beneficiary. There are also income limits for contributors, adjusted periodically. This year, eligibility phases out for modified adjusted gross incomes between $95,000 and $110,000 for single filers, and $190,000 to $220,000 for joint filers.
The funds must also be used by the time a beneficiary turns 30. If not, the remaining balance must be transferred to another eligible family member or will face taxes and penalties. Coverdell ESAs are ideal if you want to be able to use the funds for a wide range of education expenses, especially during your child’s K–12 years.
Custodial Accounts
Custodial accounts, established under the Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA), allow adults to transfer assets to a minor without establishing a trust. These accounts are not specifically designed for education but can be used for any purpose that benefits a child.
These accounts do not offer the same tax advantages as 529 or Coverdell accounts. A portion of the earnings is subject to the kiddie tax, where the unearned income may be taxed at a parent’s marginal rate. Importantly, the assets in a custodial account become the child’s legal property when they reach the age of majority (18 or 21, depending on the state).
Custodial accounts are best suited for families who want to make financial gifts to a child without restricting its use solely for education. They are also useful when larger gifts are planned that exceed annual gift tax exclusions.
Roth IRA
A Roth IRA is typically a retirement savings vehicle, but it can also be used for education expenses. Contributions to a Roth IRA are made with after-tax dollars, and earnings grow tax-free, like 529 savings plans and Coverdell accounts. While early withdrawals of earnings usually incur penalties, Roth IRAs allow for penalty-free (but not necessarily tax-free) withdrawals if used for qualified higher education expenses. Your contributions can always be withdrawn tax- and penalty-free.
The annual contribution limit for Roth IRAs in 2025 is $7,000, with an additional $1,000 catch-up contribution for those age 50 or older. Eligibility phases out between $146,000 and $161,000 for single filers and $230,000 to $240,000 for married couples filing jointly.
Remember that using a Roth IRA for education depletes your retirement savings so you must weigh the opportunity cost of sacrificing long-term growth for near-term expenses. Roth IRAs work well for families seeking a multi-purpose account with flexibility.
Traditional Savings Accounts
Of course, you can also use a traditional savings account. You can open a separate savings account in a bank or credit union, and earmark it for future educational expenses. They are accessible and easy to open, have no age restrictions, and are FDIC-insured up to $250,000.
However, interest rates on these accounts are relatively lower, compared to the other options, so your savings may not earn enough to keep pace with inflation. They also do not offer tax benefits for education expenses, which means your earnings may be subject to federal or state taxes.
You can use traditional savings accounts as a supplement to your other college savings. You may also use it as a kind of college emergency fund.
Final Thoughts
Before you choose which college savings account to use, consider your household income, target educational institution, future financial aid eligibility, tax implications, and your long-term goals. You may also layer strategies to maximize flexibility and tax efficiency. As each family situation is unique, consider seeking professional advice. These experts can provide you with tailored guidance based on your specific needs and circumstances.