Author credentials

I’m a Certified Financial Planner (CFP®) with 15+ years helping families design college‑savings strategies that balance taxes, financial aid, and long‑term goals. In my practice I often see a 529 plan work well—but not always. Below I lay out the practical alternatives I recommend, the rules to watch, and decision steps you can use to pick the right mix for your situation.

Why a 529 might not be the best fit

  • Ownership and control: If you want the beneficiary (the child) to own the money outright at 18 or 21, a custodial account may be preferable. A 529 stays under the owner’s control (usually a parent or grandparent).
  • Restricted uses: 529 withdrawals are tax‑free only for qualified education expenses; nonqualified withdrawals incur income tax on earnings plus a 10% federal penalty in many cases (see IRS Pub. 970) (IRS, Publication 970).
  • State tax/deduction limits: State tax benefits for 529 contributions vary; in some states other vehicles or direct investments offer better local tax outcomes.
  • Investment choice and fees: Some families find their state 529’s investment options or fees unacceptable and prefer a taxable brokerage account where they control investments and cost.
  • Financial aid effects: 529 plans owned by a parent or dependent student are counted differently on the FAFSA than custodial assets—this can affect aid eligibility (Federal Student Aid, studentaid.gov).

Alternatives overview (what they are, how they work, pros & cons)

1) Coverdell Education Savings Account (ESA)

  • What: A tax‑advantaged account for education expenses (K‑12 and college) that grows tax‑free for qualified withdrawals.
  • Key rules: Annual contribution limit is long‑standing and modest; income limits apply for contributors. Use rules and limits can change—confirm current limits on the IRS website (IRS, Publication 970).
  • Pros: Broader qualified uses (including K‑12), more investment choice than many 529s, tax‑free growth for qualified withdrawals.
  • Cons: Low contribution limit; contributors phased out at higher incomes; funds must generally be used by beneficiary age 30 unless rolled to another family member.

2) Custodial Accounts (UGMA/UTMA)

  • What: Brokerage or bank accounts held in a custodial arrangement for a minor; assets become the child’s at the age of majority set by the state.
  • Pros: No contribution limits; flexible uses (education or anything else once the child gains control); simple to open.
  • Cons: Loss of parental control when the child reaches the age of majority; counted as the student’s asset on FAFSA (often reducing aid eligibility more than parent‑owned 529s); investment income may be taxed under the child’s tax rules (the “kiddie tax”).

3) Roth IRA (used as a hybrid retirement/education fund)

  • What: A retirement account where contributions (and potentially earnings) may be used for education under specific rules.
  • How it helps: Contributions can be withdrawn at any time tax‑ and penalty‑free. For earnings, the IRS allows certain exceptions to the 10% early withdrawal penalty when funds are used for qualified higher education expenses—taxability and penalty relief depend on Roth ordering rules and the five‑year rule. Always check current IRS guidance before withdrawing (IRS, Publication 590).
  • Pros: Flexibility—money can stay invested for retirement if not needed for school; contributions are accessible; Roths can be a hedge against future tax increases.
  • Cons: Annual contribution limits and income eligibility rules; using retirement money for college risks underfunding retirement.

4) Taxable brokerage account

  • What: A regular investment account that offers full flexibility—no special tax‑free withdrawal rules for education.
  • Pros: No contribution limits or income tests; complete control over investments and timing; favorable long‑term capital gains rates on investments held at least a year.
  • Cons: Investment gains are subject to capital gains tax; withdrawals for education don’t get special federal tax treatment.

5) High‑yield savings accounts and CDs

  • What: Bank deposit accounts or certificates of deposit—safe, liquid, and FDIC‑insured up to applicable limits.
  • Pros: Principal protection, immediate liquidity for near‑term tuition, no early withdrawal penalties (except CD penalties).
  • Cons: Interest is taxable; returns are lower than long‑term investments.

6) Education‑qualified savings bonds (Series EE and I bonds)

  • What: U.S. savings bonds can offer favorable tax treatment for qualified education expenses if ownership, timing, and income limits are met.
  • Pros: Interest may be tax‑free when used for higher education under IRS rules and income limits; low risk.
  • Cons: Phaseouts and strict qualification rules; not as flexible as a bank account for immediate needs (see Treasury/IRS guidance).

7) Trusts and other estate strategies

  • What: Trusts (revocable or irrevocable) let families fund education with specific terms and conditions.
  • Pros: Excellent for complex or high‑net‑worth situations—control how money is used and protect assets.
  • Cons: Legal cost and complexity; potential tax rules and trust‑level taxation.
  • If you’re deciding between a trust and a 529, see our guide on when to choose a trust over a 529 for education savings (FinHelp: When to Choose a Trust Over a 529 Plan).

How alternatives affect financial aid

  • FAFSA rules treat assets differently: parental assets typically reduce need‑based aid less than student assets. Custodial accounts count as student assets (higher impact), while 529s owned by parents generally count as parental assets (lower impact). Grandparent‑owned 529s are treated differently and can affect aid when distributions are made (Federal Student Aid).
  • Taxable investments and retirement accounts may not be reported the same way—always check the latest FAFSA guidance and run a simple aid‑sensitivity model before shifting large sums.

A practical decision checklist (use this with your goals)

  1. Define the goal: Is the primary goal to guarantee tuition at a public in‑state school, to give the child maximum flexibility, or to preserve parental control? 2. Time horizon: How many years until expenses are due? Safer cash/CDs for <3 years; growth investments for >5 years. 3. Ownership and control: Do you want the child to have ownership at majority? Custodial vs parent‑owned account matters. 4. Tax benefits vs flexibility: Tax‑free growth (529/Coverdell) vs liquidity and investment choice (taxable brokerage). 5. Financial aid: Run scenarios for FAFSA and institutional aid. 6. State tax considerations: Check your state’s 529 deductions/credits and compare to alternative tax outcomes. 7. Backstop plan: If college isn’t used, what then—change beneficiary, use for other education, or for retirement?

Examples from my practice

  • Family A (flexibility): A middle‑income couple prioritized flexibility; they used a mix of a Roth IRA (for the parent’s contributions that serve as an emergency/education cushion) and a taxable brokerage account. This let them keep retirement savings intact while preserving options if their child chose vocational training.
  • Family B (control & aid considerations): A family with two small children used custodial accounts for gifts from grandparents because the grandparents wanted to give assets directly; parents then used a small 529 for tax‑efficient growth. We modeled FAFSA impact and kept custodial balances modest.

Common mistakes to avoid

  • Treating one vehicle as perfect for everything: Many families overfund a 529 without considering scholarship changes or noncollegiate education choices.
  • Ignoring retirement: Using Roth IRAs for college can be powerful, but don’t compromise retirement needs in the process.
  • Forgetting state rules: Leaving a state tax deduction on the table or failing to factor state income tax into the comparison.

Resources and authoritative references

  • IRS Publication 970, Tax Benefits for Education (explains 529 and ESA rules and distributions).
  • IRS Publication 590, Individual Retirement Arrangements (IRAs) (details Roth ordering rules and exceptions).
  • Federal Student Aid (studentaid.gov) for FAFSA rules on how assets are treated.
  • Consumer Financial Protection Bureau education and saving resources (consumerfinance.gov).

Internal resources

Practical next steps

  1. Clarify objectives (control, tax savings, aid impact). 2. Run a simple cost and aid model: estimate college cost, expected savings, and run FAFSA sensitivity. 3. Build a blended strategy: short‑term cash for near tuition, tax‑advantaged accounts where they fit, and taxable investments for flexibility. 4. Revisit annually—life changes, tax law updates, and college choices will affect the best vehicle.

Frequently asked questions

Q: Can I move money from a 529 to another account if plans change?
A: Yes—options include changing the beneficiary to another family member, rolling to another 529 plan, or taking a nonqualified withdrawal (which can trigger income tax on earnings and a 10% penalty). Recent legislative changes occasionally add limited rollover options—check current IRS guidance and consult your plan administrator before making moves (IRS, Publication 970).

Q: Are custodial accounts always worse for financial aid?
A: Not always. While custodial accounts count as the student’s asset and can have a larger immediate impact on aid, moderate-sized custodial gifts and strategic timing (using funds before FAFSA filing) can reduce the effect. Work with a planner or use FAFSA calculators to compare outcomes.

Q: Should I use a Roth IRA only if I can fully fund retirement first?
A: Prioritizing retirement is generally sound—federal aid, scholarships, or loans may fill education gaps, but you can’t retroactively rebuild retirement savings easily. Consider a partial approach: contribute enough to retirement to stay on track, then use other vehicles for education.

Professional disclaimer

This article is educational and does not substitute for personalized financial, tax, or legal advice. Rules for 529s, ESAs, IRAs, and financial‑aid calculations change over time. Consult a CFP® or tax professional and review current IRS and Federal Student Aid guidance before making decisions.

Last reviewed: 2025 (confirm current contribution limits and tax rules with IRS and your state).

Authoritative sources cited

  • IRS Publication 970, Tax Benefits for Education (irs.gov)
  • IRS Publication 590, Individual Retirement Arrangements (irs.gov)
  • Federal Student Aid (studentaid.gov)
  • Consumer Financial Protection Bureau (consumerfinance.gov)