529 Plan vs. Savings Account

It’s never too early to start saving for college. Whether you’re a new or seasoned parent or a loving grandparent, planning for the kids in your life is smart. As you consider how to save for education expenses, there are two types of accounts to choose from: 529 plan vs. savings account. 

529 plans are tax-advantaged investment accounts that allow you to save money for qualified educational expenses, including tuition for K-12 education. The account offers tax-free growth and tax-free withdrawals as long as funds are used for secondary education purposes. 

Savings accounts are another way to set aside money for educational expenses. These accounts are typically federally insured, and you can save any amount. Ultimately, the best account depends on your timeline, financial goals, and the amount you save. Here’s how to choose. 

What are the differences between a 529 college savings plan vs. a savings account?

A 529 college savings plan is an investment account, while a savings account is a deposit account. The accounts also have different tax implications and growth potential. 

One of the most significant differences is how you can use the funds. There aren’t any restrictions on how you use the money in a savings account. Meanwhile, you pay a penalty if you spend the money in a 529 college savings plan on anything other than eligible education expenses. 

Here is a glimpse at the major differences between a 529 plan vs. a savings account.

	529 savings plan	Savings account
Tax advantages	✅	❌
Contribution limits	✅	❌
Increased risk	✅	❌
Usage limits	✅	❌
Limited returns	❌	✅
Transferable	✅	✅
Withdrawal penalties	✅	❌
FDIC insurance	❌	✅

Benefits of 529 plan vs. savings account

Both 529 plans and savings accounts offer unique perks. As you determine which account makes the most sense for you, consider your financial priorities and how they align with the benefits of each account. Here are the top features of 529 plans vs. savings accounts.  

Benefits of a 529 plan

Consider the following benefits to determine whether to move forward with a 529 plan. The plans offer tax-free growth, the potential for higher returns, and minimal impact on financial aid eligibility—all of which can add to substantial savings. 

• Tax-free growth and withdrawals: You pay income tax on funds contributed to a 529 plan when you place them in the account. This allows your money to grow tax-free, and there aren’t any additional taxes to pay when the beneficiary withdraws from the account for qualified education expenses. 
• Potential for higher returns: Because 529 plans are investment accounts, your money might earn higher returns than it would in a savings or checking account. Most savings accounts offer interest rates of less than 1%. You can earn a higher rate with a high-yield savings account, but it’s still less than typical market returns. 
• Financial aid eligibility: 529 plans impact a student’s financial aid package less than other account types. The accounts are considered an asset of the owner, typically the student’s parent. Because of that, only 5.64% of the account’s value counts against financial aid eligibility.
• State tax break: Some 529 plans provide state income tax deductions of up to $3,000 per year. If you live in a state that offers an additional tax incentive, you can save even more money during tax season. 
• Option to transfer the account: If your child does not need to use the entire account balance, you can transfer the remaining funds to another child. For families with more than one child, it’s a helpful feature. 

Benefits of a savings account

Savings accounts allow you to store money with minimal risk. Plus, most accounts offer FDIC insurance, which ensures your money is safe if the bank fails (up to FDIC limits). Here are the benefits of using a savings account to prepare for education costs. 

• Flexible spending: There aren’t any restrictions on how you spend the money in your savings account. For example, imagine you save $60,000 for your oldest child to attend college. He decides to become a flight attendant instead, which includes paid training. Changing plans isn’t a big deal if your money is in a savings account. You can give the funds to your child to help pay for a down payment or other significant expenses in a few years. 
• Account liquidity: You can withdraw from a savings account at any point without penalty. Saving for college usually spans multiple years, and unexpected expenses might arise. You can access the funds for an emergency while building the account. 
• FDIC insurance: When you open a savings account with an FDIC-insured bank, you can access FDIC insurance. The insurance protects your account and ensures that you are reimbursed for up to $250,000 per account if the bank fails.

Downsides of 529 plan vs. savings account

Even though both account options have valuable features, there are potential drawbacks. Here are the pitfalls to consider as you determine whether a 529 college savings plan or savings account makes the most sense. 

Downsides of a 529 plan

• Potential withdrawal penalties: You must pay a 10% penalty fee and income tax if you withdraw funds from a 529 plan for nonqualified expenses.
• Must use funds for education: 529 plans are college savings plans, which means you must use the funds for qualified education expenses. 
• Contribution limits: 529 accounts have aggregate limits, the maximum total amount you can contribute. Depending on the state, the amounts range from $200,000 to over $500,000. For most savers, the maximum contribution limit is high enough that it’s not a concern. But if you want additional flexibility or intend to save extra, it might be an issue. 
• Investment fees and limited control: Depending on your plan, you might pay hefty investment fees. Plus, you might have limited control when choosing funds or specifying investment picks. 

Downsides of a savings account

• Lower interest rates: Most traditional savings accounts offer interest rates of less than 1%. You can typically secure a higher rate with a high-yield savings account. But the returns are usually smaller than you can earn with an investment account. 
• Impact of inflation: Saving for college is usually a long-term goal that spans multiple years. Because of that, you might feel the impact of inflation if your money isn’t earning interest. 
• No tax advantages: Savings accounts do not offer any tax advantages. One of the biggest perks of a 529 plan is that the money can grow tax-free, which can add up to thousands of dollars of savings. There’s no equivalent perk with savings accounts.
• Harder for others to add gifts: If family members and friends want to contribute to the account for your child, they would need to give you cash, a check, or a digital deposit. It might feel more complicated or convoluted than having the family direct deposit into a specified 529 account.

Should you choose a 529 plan or savings account?

College is a significant financial investment with an average cost of $36,436 per year. The fact that you are planning to set aside money is a great first step. As you choose the account for your education savings, consider your personal finances. 

Speak with a financial advisor and review your retirement savings and emergency fund before planning to save for future education expenses. If you still can’t decide, consider these scenarios.

Consider a savings account if:

• You want to minimize risk. Savings accounts are one of the safest places to store money. Your money may not grow as quickly as it could in another account, but it won’t lose value.
• College is already covered. If you already have enough savings, income, or gifts to pay for college costs, you don’t need a 529 plan. 

Consider a 529 plan if:

• You’re nervous about affording tuition. It can be intimidating to save for a considerable expense like college. A 529 plan is a straightforward way to start. 
• You want to maximize tax savings and earn higher returns. The accounts allow you to invest money and save on taxes. It’s a unique combination. 

Consider opening both accounts if:

• You want maximum flexibility. You can open both accounts to take advantage of the benefits of each.

Tip

Instead of a typical low-interest bank savings account, you can also consider opening an investment brokerage account. Funds can be invested however desired. Depending on the investments, it may carry slightly higher risk, but it can also lead to higher returns. 

How should the age of the beneficiary affect your choice of college savings vehicle?

Rand Millwood

CFP®

If you get to within just a few years of the beneficiary beginning college, there is a limited amount of time for a 529 account to grow to provide significant benefits relative to the flexibility of a savings account. Contribution limitations are minimally affected by the time period.

FAQ

How do 529 plans and savings accounts affect financial aid eligibility?

A 529 plan owned by a parent or dependent student is considered a parent asset on the Free Application for Federal Student Aid (FAFSA). It may affect a student’s aid eligibility less than a regular savings account because only a maximum of 5.64% of parent assets are considered available for college costs. 

In contrast, savings accounts may be counted as an investable asset, which could reduce aid further.

Can I transfer funds from a savings account to a 529 plan?

Yes, you can transfer funds from a savings account to a 529 plan. As part of the IRS’s gift-tax exclusion in 2024, you can contribute up to $18,000 ($36,000 for married couples) per beneficiary per year. This can represent a sizable transfer, especially if you aim to front-load the 529 plan.

How soon can I access funds in an emergency from both accounts?

For most savings accounts, access to funds in an emergency is immediate. You can withdraw from your savings account at any time. 

With a 529 plan, it’s more complex. Withdrawals for nonqualified expenses are subject to income tax and a 10% penalty on earnings. So it’s often less accessible for immediate emergency funding.

Is it possible to lose money in a 529 plan?

Yes, it’s possible to lose money in a 529 plan. These plans often invest in mutual funds or similar investments. Investments come with risk, so your account value can fluctuate with market changes. 

It’s important to select a portfolio that aligns with the account beneficiary’s age and your risk tolerance.

Are there age or time limitations on using 529 plan funds?

There are no age or time limits for using the funds. Whether the beneficiary attends college fresh out of high school or as a mature student, the funds will support them. 

The account can also be passed down to a future generation, extending its lifespan if the initial beneficiary doesn’t use all the funds.