Saving for college can be tricky. With rising tuition rates, inflation, and a number of other factors at play, families of college-bound students need to be in savings mode for years before the actual start date. 

That’s why many families rely on 529 college savings plans, a type of investment account with tax advantages, to save for their higher education needs. But for those who want to forgo one, there are ways to save for college without a 529.

Why would an investor save without using a 529 plan? 

The 529 plan is a qualified tuition program (QTP) designed to encourage people to save for future education expenses. These plans can be used for certain education expenses from tuition, books, and fees to computers, internet access, and education software. There are two types of 529 plans: prepaid tuition plans intended for tuition and fees, and the more flexible education saving plans that can be used for room and board and other education expenses.

These plans are popular because of their tax advantages—typically, as long as money stays in the account, no income taxes are due on the earnings. Savings in the plan can affect a student’s financial aid status, but that impact is usually minimal when the parent or other family member owns the account. When money is withdrawn for eligible education expenses, it may be federal income tax-free. 

Most people start with a 529 plan because it is the most widely known savings vehicle for college. But it’s not without its limitations. These include:

• Penalties.

  Account holders may incur income tax plus a 10% penalty on earnings for non-approved withdrawals, such as taking money out for non-education expenses. 

• Limits on 529 balances.

  While the IRS does not set annual contribution limits for these plans, federal law does: 529 plan balances cannot exceed the expected cost of all college expenses. Total contribution limits also vary by state. 

• Limited investment option.

  529 plans are known to have limited investment options such as mutual funds and exchange-traded funds (ETFs), which can only be changed twice a year. 

• Uneven state tax deductions.

  There are no uniform rules for state income tax deductions or credits. For example, New York’s NY 529 college savings plan provides a deduction of up to $5,000 for single filers ($10,000 married, filing jointly) while Rhode Island’s CollegeBound Saver offers a $500 deduction for individuals ($1,000 married, filing jointly).

• Fees.

  Fees and expenses can vary depending on the type of 529 plan, investments, and management. A 529 plan can include mutual funds, target-date funds, and ETFs, so there may be fund expenses that are calculated as a percentage of assets. Fund expense ratios and other fees can cut into returns. 

For these reasons, an investor may seek alternative ways to save for college.

4 Alternatives to saving for college without a 529 plan 

Sometimes, a 529 may not be the best option for families and students to pay college costs, depending on their goals and timeline for savings. In such cases, they may turn to these four alternative ways to save for college.  

1. Savings accounts

Savings accounts

are the most basic savings device and can be opened at any local bank. These deposit accounts are liquid so there’s quick and easy access to money. 

There are a couple of benefits of using a savings account to put away money for college:

• Freedom of usage.

  Money in the account can be used for anything, even non-educational purposes. 

• Fewer penalties.

  Typically, money can be deposited and withdrawn without penalty, as long as no more than six transfers or withdrawals are made per month, within certain conditions, as allowed under the Federal Reserve’s Regulation D.

• Very low risk.

  There is no investment risk associated with savings accounts, as the money is not invested in the market.  

There are also a few downsides of using a savings account to put away money for college:

• Lower savings rates.

  Most traditional savings accounts offer lower interest rates than other savings vehicles like bank certificates of deposits and money market accounts, which can yield more than 10 times that of a regular savings account. Therefore, returns will be lower. 

• Minimum balances.

  Depending on the account, there may be a required minimum balance to avoid monthly penalties.

• Age requirements.

  Minors under the age of 18 may not be able to open an account without an adult enrolling as a joint account owner.

2. Roth IRAs

Another way to save for college is to take advantage of a Roth IRA. This is a special type of individual retirement account that allows the account holder to make tax-free qualified distributions. But these accounts are traditionally used to save for retirement—not college. Still, there are exceptions for tapping early without incurring the 10% penalty and having to pay income taxes on withdrawals. One is when paying for qualified education expenses. There are specific income limits, distribution rules, and other eligibility requirements to understand when considering this retirement savings account.

There are several benefits of using a Roth IRA to save for college such as: 

• Fewer penalties.

  If the account holder is over the age of 59½, they can take money out of the account penalty-free, which can be used to help finance their child’s education, for example.

• Penalty-free exceptions.

  If the account holder is younger than 59½ and paying for higher education for themselves, their spouse, or their children, then they are able to withdraw money from an IRA without penalty.

• Limited impact on financial aid.

  If the parent owns the account, then there is minimal impact on financial aid—a maximum 5.64% of its assets are considered in calculating federal student aid. The money is not taxed upon withdrawal. 

There are also a few limitations when using a Roth IRA to save for college: 

• Income limits to open.

  Not everyone is eligible to open a Roth IRA, putting it off-limits to some as a savings option for tuition and other education-related expenses. Single taxpayers with income of more than $129,000 are ineligible as are couples who make more than $204,000 and file jointly. 

• Contribution limits.

  If income requirements are met, contributions max out each year at $6,000 for account owners under the age of 50 and $7,000 once reaching age 50. 

• Inherited IRAs can impact financial aid.

  If a student or future student inherits an IRA from someone who passes away (a grandparent, for example), the distributions from that account will count as income, and that can affect their eligibility for income-based financial aid. 

3. Custodial Accounts

Custodial accounts are unique accounts opened and managed by an adult for a minor—but the minor ultimately owns the account. There are two types: the Uniform Gifts to Minors Act (UGMA), which can hold cash, mutual funds, and other financial securities; and, Uniform Transfers to Minors Act (UTMA) account, which can hold and transfer money, real estate, or other properties to a minor. 

The key benefit of using a custodial account is flexibility: there are no limits on what the money in the account can be used for, as long as it is used to benefit the child in some way. A student could use funds for expenses not covered by a 529 plan like off-campus housing or a college trip with friends.  

Additionally, there are a couple of limitations of using custodial accounts: 

• Mandatory approvals.

  For the student to make transactions or take money out before taking ownership, approval is always needed from the custodian, a potential drawback in an emergency.

• Higher expected contribution amount.

  Because the child is the owner of the account, a higher percentage of its value (20%) is considered when calculating federal student aid. This can have a significant impact on the amount of a child’s potential financial aid award.

4. Brokerage Accounts

For financially savvy investors, brokerage accounts might be good options when it comes to college saving. Brokerage accounts are investment accounts used to buy and sell securities, such as stocks, bonds, mutual funds and ETFs. 

The benefits of saving for college through brokerage accounts are:

• Fewer penalties.

  Anyone can put money in and take money out at any time without the risk of a penalty. 

• Freedom to diversify.

  The account holder gets to decide where to invest and can diversify their portfolio (including picking stocks) as they see fit. 

• Opportunity to maximize return.

  There is inherently more risk. But that also means there is a greater opportunity for reward as the account grows. 

The disadvantages of using brokerage accounts to save for college include:

• No tax advantages.

  Brokerage accounts do not offer tax savings. If investments in the account make money, taxes will be due. 

• Some have fees

  . This can be a monthly flat rate or a commission based on the size of a transaction. 

• Minimum balance.

  Some firms require a minimum balance to open and maintain an account. 

• No guarantee on investment.

  The biggest risk is that money put into a brokerage account is not guaranteed. When stocks fluctuate, so do the values of the stocks, bonds, and ETFs. 

Considerations when choosing a savings plan for college

Families are not beholden to one type of savings vehicle when mapping out how they will finance a higher education. Families might want to consider more than one savings plan, or a combination of investment vehicles. 

There are also supplementary methods for financing a higher education such as government financial assistance and scholarships. The free application for federal student aid (FAFSA) is the form families fill out—and colleges use—to determine financial aid eligibility for grants, loans, scholarships, and work-study jobs.

The bottom line

Saving for college can be tough, but with the right tools and information, it is not impossible. There are a number of alternative methods that can be used to fund a higher education, such as savings accounts, IRAs, custodial accounts, and brokerage accounts.