Your guide to college savings plan options: From 529s to Coverdells

With the average cost of college climbing to $38,270 per year, it’s easy to feel overwhelmed. But don’t let the sticker shock stop you—starting to save early can make the goal feel much more within reach. The good news? You have a variety of savings options to explore, each with its own perks and considerations, from tax benefits to financial aid impacts.

With so much at stake, it’s worth exploring the options to find the right fit for your family’s goals. From 529 Plans to Coverdell ESAs and more, understanding the advantages of each can help you make an informed choice.

A 529 Plan¹ allows you to save for education-related expenses on behalf of a minor. Any growth of your investment is tax-free, and you can withdraw it tax-free to pay for qualified education expenses. It is important to know that the earnings on investments in 529 Plans are not guaranteed and can lose value based on market conditions.

These plans are typically administered at the state level, have high contribution limits and may offer a tax deduction, depending on the state.

• Contribution limits are dependent on the state. But note that contributions are considered gifts for federal tax purposes. Contributions above $19,000 in 2025 must be reported on IRS Form 709 and will count against the taxpayer’s lifetime estate and gift tax exemption amount.
  

• Tax-deferred growth. This means you won't owe federal income tax on any interest or returns your contributions earn each year.

• Tax-free withdrawals. If you use the money to cover qualified college expenses and K-12 tuition costs, there will be no tax liability on your withdrawals.

• The ability to transfer a 529 plan to eligible family member. Let's say your first child gets a full scholarship to college but you have money sitting in a 529 Plan. You can change the beneficiary to your younger child and use the money to pay for that child's college. You also could put the account in your own name or transfer it to another eligible relative.

• The SECURE Act 2.0 changed the rules for unused 529 Plan funds. 529 Plan beneficiaries will have the ability to transfer excess funds from their 529 Plan to a Roth IRA without paying taxes or penalties, give certain criteria are met. Learn more about the requirements

• There are no income limits that could exclude a person from contributing. Some other plans have income limitations attached to them.

• There is no age limit for distributions. Some college savings vehicles have a designated age that funds must be used by.

• Financial aid eligibility. The child's financial aid may be impacted, especially if the account is in their name.

• Limited flexibility. Remember to take into account the possibility of your child getting a full scholarship or having a family member contribute to their higher education costs. Depending on state requirements, you may not be able to use this money for non-education purposes. However, they still may be used to pay for housing expenses. When you use these funds for non-educational costs, there is typically a 10% penalty and income taxes on the earnings within these withdrawals. (This penalty is waived in the event of a death or disability.) If you want more flexibility because you are worried about the possibility of the 529 Plan going unused, consider an alternative.

A Coverdell Education Savings Account is a type of trust or custodial account that allows you to save money and invest to cover future college costs. Similar to a 529 Plan, contributions and earnings can grow tax-free, and you can withdraw them tax-free to pay for qualified education expenses. Otherwise, any nonqualified withdrawals will be subject to a 10% tax penalty on earnings.

One key distinction between a 529 Plan and a Coverdell account lies in their limitations. Coverdell accounts come with much lower contribution limits and have an added hurdle: your family’s income must fall below a specific threshold to qualify.

• Annual contribution limit: $2,000

Let's explore all of the differences side by side:

Roth and traditional IRAs are typically thought of as strictly for retirement, but they also can be used to pay for college. You can take a qualified education distribution from an IRA to pay education expenses for you, your spouse, children or grandchildren. Qualified education expenses include tuition, fees, books, supplies and equipment necessary for attendance at any college, university, vocational school or other postsecondary educational institution eligible to participate in the U.S. Department of Education's student aid programs.

• 2024 & 2025 IRA contribution limits: $7,000 under age 50; $8,000 age 50 or older

A traditional IRA allows you to save pre-tax dollars for retirement and, in most cases, receive a tax deduction on your contributions. Even better, your savings can grow tax-deferred over time, helping you build a nest egg faster.

But be mindful—if you dip into your IRA before age 59½, you'll face a 10% early withdrawal penalty plus income taxes, which can shrink your savings significantly.

With a Roth IRA, you contribute after-tax dollars, and your money grows tax-free—no strings attached. Need to dip into your contributions? You can withdraw them anytime, tax- and penalty-free. Plus, once you hit 59½ and have held the account for at least five years, even your earnings can be withdrawn tax- and penalty-free.

The main advantage of using an IRA for funding college is the penalty-free withdrawals for qualified education expenses. This option can give your family financial flexibility if the student doesn't receive enough financial aid or scholarships to pay for college. This also may help your student avoid loans and debt after they graduate.

There are downsides to using an IRA to cover college costs. Withdrawals will reduce your savings earmarked for retirement and you'll potentially miss out on the tax-free or tax-deferred growth on the amount you withdraw. You'll likely also pay income taxes on any earnings you withdraw, and you have to make sure you fully understand what specific education expenses qualify or you could face the 10% penalty.

Additionally, your withdrawals, even if qualified, may count as income if your family files the Free Application for Federal Student Aid (FAFSA). The withdrawal will count as part of your total income and could affect your expected family contribution, which is the total amount a school expects your family to contribute to the student's college expenses. It also could affect the potential financial aid your student receives. The FAFSA requires families to report income from the two years prior to when they request financial aid, so the timing of your IRA withdrawals is critical.

A general investment account, or a brokerage account, is among one of many college savings plan options. With this account, you have more freedom to choose how you invest—whether it's in a mutual fund, index fund or individual stocks and bonds.

• Contribution limits: There is no cap on how much you can contribute every year, and you have more flexibility to withdraw whenever you want and for whatever purpose you choose, including paying for college.

There are tax implications depending on how long you've held assets in the account. You may have to pay short- or long-term capital gains taxes on any gains you withdraw. If you sell any assets in your account that you've had for less than a year, you'll have to pay the short-term rate, which is the same as your ordinary income tax rate. Long-term capital gains tax applies to assets you've held for at least a year. These taxes are generally lower and range from 0% to 20%, depending on your individual or joint income.

Using a general investment account to pay for college expenses comes with its own pros and cons. Similar to an IRA, you'll potentially sacrifice tax-deferred growth on the amount you withdraw.

Another consideration is that the amount you withdraw will count as income and factor into your expected contribution and financial aid package. However, the revised Free Application for Federal Student Aid (FAFSA) no longer calculates an Expected Family Contribution—a.k.a., EFC. Instead, a new factor called the Student Aid Index, or SAI, now influences how much federal need-based financial aid an applicant receives.

However, the upside of using a general investment account is that you don't have to worry about qualified education expenses. If you want to use the money to buy the student a car to get around campus or to or from their internship, you can do that. It doesn't just have to pay for tuition, fees or books.

Getting ahead of the FAFSA

Preparing for the FAFSA and making strategic financial moves ahead of time can reduce the chance of surprises and maximize your possibilities. You can take steps now to get a sense of how much you'll be able to contribute and how you can help your child qualify for a better financial aid package.

Read more

There are two main types of custodial accounts: UGMA & UTMAs. The main difference between UGMA and UTMA accounts is the type of assets you can hold in each.

UTMAs can hold almost any asset type, including:

• real estate
• collectibles
• fine art
• royalties

UGMA holdings are limited to:

• cash
• insurance policies
• investment assets like stocks, bonds or mutual funds

Each account has one designated custodian (typically a parent) and one designated minor beneficiary. However, the major drawback of custodial accounts is that the assets in these accounts are irrevocable, meaning the contributions made to the account belong to the beneficiary. You can't take them back or make withdrawals.

• No limit on the amount you can contribute or no income eligibility limit.

• Contributions are considered gifts, subject to the annual gift exclusion ($19,000 per individual, $38,000 per married couple). Beneficiaries who are under 19 years old, or under 24 and a full-time student, and whose taxable income in 2025 is below $1,350 aren't subject to taxes. After that, the next $1,350 in unearned income is taxed at the child's income tax rate (any income in the account over $2,700 in 2025 is taxed at the custodian's federal income tax rate).

• You also can use this account for any purpose—not just to pay for college—so it's much more flexible than an IRA, 529 or Coverdell college savings account.

• They can affect financial aid. Currently, up to 20% of a child's assets count toward the expected family contribution. Since a child is the owner of the UTMA or UGMA, the assets in this account likely will affect your family's out-of-pocket costs for college more than if the same amount of money were held in an account you owned as their parent.

• UGMA and UTMA accounts also must be terminated when the beneficiary reaches age 18 and 21, respectively, and the assets in the account must be distributed to the beneficiary. Keep this in mind if you intend to use this account as a college savings vehicle because once your child reaches these age thresholds, you can't control what they do with the assets in the account.

Permanent life insurance and trusts are two non-traditional college savings plan options.

Permanent life insurance features what's known as cash value. When you have a policy, a portion of your premiums are invested and may grow tax-deferred over time. You have the flexibility to withdraw your policy's cash value while you're still alive for any purpose. You can make withdrawals as a loan or as a straight distribution, but doing so will affect the death benefit your beneficiaries receive after you pass away³. However, you can choose to pay back the loan, which would avoid this.

With a trust, you can structure it any way you choose, including requiring that distributions only be used for education. A trust allows you to have more control over assets contained within the trust, how they are invested and how they are distributed. You can establish qualified transfers that generally do not affect beneficiaries' annual or lifetime exclusion, which is the maximum amount you can transfer to someone else as a gift.

Depending on how much you gift a child or family member, how you structure the trust, and the beneficiary's access to the trust, it may affect financial aid in varying ways. For example, the value of the trust may restrict the child's eligibility for need-based financial aid altogether.