Saving for college: 529 plans and beyond

Having reaped the reward from investing in higher education, it is natural for physicians to hope for the same for their children. But the cost of that education continues to climb and climb. If we can make that road a little easier for our kids, we do it. 

In my last blog, I introduced a college education savings calculator that is available in the "financial tools" page on my website.  This is an easy-to-use tool to figure out how much you need to save for your kids.  Today's article is about some of the options available on how or where to save that money, including pros and cons of each method.

529 plans

This is currently the most widely used and best-known vehicle for college savings.  And there is a good reason for that.  There are great advantages to 529s, and these plans have become even better over time.

What is a 529?  It is a tax-advantaged savings plan named after Section 529 of the Internal Revenue Code.  These are managed by the states and, at this point, each state has their own plan. (You do not need to use the plan of the state in which you reside.) They work  similar to a work-place retirement account, where you choose from a group of investment options (typically a mix of stock and bond mutual or index funds) in a pre-selected allocation percentage.

What are the tax advantages? Unlike your 401(k), you invest in a 529 using after-tax dollars although many states give a state income tax deduction on amounts invested that year, particularly if you are a resident of the same state that holds your funds. Like other tax-advantaged accounts, the growth on the assets is tax-free.  And, if you use it for qualified educational expenses, you do not pay federal income tax when you spend it. 

What are qualified expenses? Tuition, room and board, books and supplies, computers.  Plus, you can use up to $10,000 per year for K-12 (tuition only).  And you can use up to a total of $10,000 per beneficiary for student loan repayment.

Any other advantages? One is that, unlike a UTMA for example, the account owner retains control of the funds, even after the beneficiary reaches adulthood.  This means that the owner can change the beneficiary at any time. And, the funds do not count as student assets for federal student aid calculations.

Any disadvantages? The main one, and it has the potential to be a big one, is the lack of flexibility on how you can spend the money.  If you do not spend it on a qualified educational expense, you pay ordinary income tax on the distribution plus a 10% penalty.  So, if your child chooses not to go to college (or obtains a scholarship that pays their own tuition) and you still want to give them the money, it will come with a price.  Thankfully, as part of the SECURE 2.0 Act passed in 2022, Congress created a provision where up to $30,000 of unspent 529 funds can still be passed to the beneficiary by way of a Roth IRA as long as the account has been open for at least 15 years. 

What else can you do with an overfunded 529?  Remember that you can change beneficiaries at any time. So, if the original beneficiary doesn’t end up using it, you can give it to one of their siblings, save it for grandchildren, or give it to another close family member.  Or you can just take the tax hit, pay the penalty, and spend it on whatever you want.

Coverdell Educational Savings Accounts (ESA)

What are they? This is another type of tax-advantaged college savings plan with some important differences from 529s.  They are generally available through brokerage companies and also some banks. 

What are the advantages? Like 529s, the contributions are made with after-tax dollars, investments grow tax-free, and withdrawals are tax-free when used for qualified educational expenses. Unlike 529s, you can use these for all K-12 and college expenses including tuition, books, supplies, room and board, computers and even tutoring.  (529s only allow you to pay tuition for K-12). ESAs also have more flexibility with investments.  Rather than a limited choice of options like 529s, you are typically able to invest in anything that the sponsoring custodian offers including individual stocks, mutual funds or ETFs.

What are the disadvantages?  ESAs have contribution limitations of only $2000 per child per year. (Contributions to 529s are only limited by the gift tax amount per individual contributor—currently $18,000 per year—with an unlimited number of contributors.) You can only contribute to an ESA until the beneficiary turns 18.  There are also income limits on who can contribute.  Income phaseouts start at $95k (single filers) and $190k (joint filers) where you are no longer eligible to contribute, so most physicians cannot use them. Also, the funds must be used by the time the beneficiary turns age 30. (You can change beneficiaries within the family as long as the new one is less than age 30).

Series EE or Series I US Educational Savings Bonds

What are they? These are specific types of US Savings Bonds (loans to the government) that pay you interest over time.  If you use that interest to pay for qualified educational expenses (tuition and fees only, not room and board), you do not pay federal income tax on the interest.

What are the rules? The bonds are owned by the parent (not the child) which means they do not count as a student asset for financial aid purposes.  The expenses must be paid in the same year as the bond is redeemed to claim the tax deduction.  The bond owners modified adjusted gross income (MAGI) must fall below a certain limit (phaseout complete at $167,800 for joint filers). So, again, most physicians will not be eligible for the tax deduction because of their income. You can spend the money on anything you want but you don’t get a tax break if not used for educational purposes.

UTMA/UGMA accounts

What are they? These are taxable custodial investment accounts that can be set up for your children through brokerages or banks.  Like ESAs, you can invest in whatever options that the brokerage offers.  With these types of accounts, the beneficiary is the owner of the asset, and the parent is just the custodian.  The donations are a complete and irrevocable gift to the beneficiary. Any money spent from those accounts before the child reaches adulthood must be spent directly for the benefit of the child.  And, when they reach age of majority (usually 18 or 21, depending on the state), the child has full access to the money to use however they want (they can blow it all in Vegas rather than pay for their tuition). 

What is the main advantage?  Flexibility.  You don’t have to use that money for educational expenses but can spend it on whatever makes the most sense.

What are the disadvantages? It is your child’s money.  You can’t control how they spend it after they reach adulthood.  They might not spend it how you had hoped or intended.  Too bad!  It’s theirs now.  Also, there are no tax advantages.  Taxes are owed yearly on income and dividends.  Capital gains taxes are due on the growth when assets are sold.  The tax rules are a little bit complicated because some of them are at the child’s rate and some of them are at the parent rate (look up Kiddie Tax Rules).  And they count as student assets for federal student aid calculations (meaning that they will be eligible for less assistance).

Save in your own taxable account or pay as you go

There is nothing that says you have to use a specific educational savings plan to pay for your child’s education.  You can just pay for it out of your current assets or earmark a taxable account that you retain control over for your children’s education. 

Advantages: The main advantage is that you have complete flexibility with that money.  If your kids don’t go to college, you are free to redirect the funds to anything else without penalty. 

Disadvantages: These are not tax-advantaged accounts, and it requires discipline on your part to not spend it on other things before you can use it for their intended purpose.  If you haven’t planned ahead for college expenses and you just end up paying them from your current income, it can be a major financial stressor. This is especially true if you have multiple children who will all be attending college around the same time.  So, if you don’t plan on using one of the tax-advantaged accounts, I would still recommend earmarking an account for children’s education, investing early and regularly, and letting the power of compounding interest work in your favor to decrease the hit from college tuition inflation (which is almost always higher than regular inflation).

Summary

Physicians, having experienced the immense cost and value of higher education, naturally want to ease that burden for their children. In addition to understanding how much to save (as introduced in the previous blog with the college savings calculator), it’s equally important to understand where and how to save. This post outlines the major college savings options, including their pros and cons, to help families make informed decisions.

Below is a comparison table summarizing the key features of the major college savings vehicles:

Feature	529 Plan	Coverdell ESA	UTMA/UGMA	Education Savings Bonds	Taxable Account (Parent-owned)
Tax Benefits	Tax-free growth & withdrawals for education	Tax-free growth & withdrawals for education	Taxed annually (Kiddie Tax rules may apply)	Tax-free interest if income limits met	Taxed annually on income, dividends, gains
Contribution Limit	High (varies by state; often > $300k total)	$2,000/year per child	No formal limit (gift tax rules apply)	$10k/year per bondholder	No formal limit
Income Restrictions	None	Yes – income phaseouts apply	None	Yes – income phaseouts apply	None
Qualified Expenses	K–12 tuition (up to $10k/yr), college, loans	K–12 & college (incl. tutoring)	Any use allowed (not restricted to education)	Tuition and required fees only	Any use allowed
Investment Control	Limited to plan’s options	Broad – individual stocks, ETFs, etc.	Broad – custodian chooses until majority	No investment control	Full control
Control of Funds	Account owner maintains control	Custodian until age 30	Child gains control at 18–21	Parent controls until redeemed	Parent retains control
Financial Aid Impact	Considered parent asset (favorable)	Considered parent asset	Considered student asset (less favorable)	Considered parent asset	Considered parent asset
Use-It-Or-Lose-It?	Penalty if not used for education	Must use by age 30 or reassign	No – funds become child's property	No – just lose tax benefit if misused	No – complete flexibility
Other Notes	Can roll up to $30k into Roth IRA (SECURE 2.0)	Low contribution cap; most physicians ineligible	No tax advantage; child's control at maturity	Most physicians exceed income limit	High flexibility; needs discipline to earmark

Each option has its place, depending on your financial goals, tax situation, and desired level of flexibility or control. For many, a 529 plan remains the core vehicle due to its generous tax advantages and high contribution limits. But for those who need more flexibility, or fall outside of eligibility limits, alternatives like UTMAs or taxable accounts may make more sense.

Being intentional with your strategy—even if that means combining multiple vehicles—can help ensure you’re ready when the tuition bills arrive.

Explore the calculator, run your numbers, and choose the right tools for your family. Reach out to us at www.targetedwealthsolutions.com if you would like to explore how we can help you with this and other important financial planning considerations.

Disclaimer: the material in this blog post is intended for general educational purposes only and should not be considered specific financial advice. You should always consult with your personal financial advisor to see how it might fit within your personalized financial plan.