529 Plan vs. Brokerage Account For Children Investing

When it comes to saving for college, families usually have to make the choice between a 529 plan and a brokerage account. The good news is that if you are saving in either account, you are ahead of the game. 

But if you want to choose the best account option for your situation, it’s helpful to review all of the details.

We explore both 529 plans and brokerage accounts to help you select the right account for your situation. 

What Is A 529?

A 529 plan offers a popular way to save for college costs. Although these plans were originally intended to cover higher education costs exclusively, the rules have expanded to include private K-12 costs and apprenticeship programs as an acceptable use of the funds.

529 plans can be broken down into two categories: prepaid tuition plans and college savings plans. Depending on your state, a prepaid tuition plan, college savings plan, or both might be available.

Like all accounts, there are advantages and disadvantages to consider.

529 Advantages

Let’s start with the advantages:

• Tax advantages: The contributions you make to a 529 plan can grow tax-deferred. When you make a withdrawal for a qualified educational expense, the funds aren’t subject to federal income tax. 
• Tax Deductions or Credits: Many states offer tax deductions of credits for contributions to a 529 plan.
• Range of qualified expenses: In addition to college costs, you could use the funds to pay for an apprenticeship program, student loans, or even potentially roll the funds into an IRA. This allows families more flexibility. 

529 Disadvantages

Of course, there are also some downsides to consider:

• Tax penalties: If you use the funds from a 529 to pay for something other than a qualified education expense, you’ll face federal income tax and an additional 10% penalty. You might also have a state 529 plan penalty.
• Limited investment options: In many 529 plans, you don’t have many investment options. Most states offers target-date funds, a stable value fund or savings account, and a variety of individual mutual funds. Depending on your portfolio goals, this could be a significant drawback. 

What Is A Brokerage Account?

A taxable brokerage account is an investment account available through many financial institutions. When you open a brokerage account, you can tuck away funds into your portfolio with the intention of paying for your child’s college costs someday.

For children, a brokerage account is titled as either a UTMA or UGMA account. This means that a parent is usually the custodian for the child.

Although brokerage accounts aren’t specifically designed with college costs in mind, many parents build up a nest egg intended for higher education down the line. Here are some pros and cons to consider.

Brokerage Account Advantages 

Let’s look at the advantages first:

• Broad investment options: Through a brokerage account, you have access to a wider range of investment options. For example, you’ll likely have the pick of individual stocks, mutual funds, bonds, ETFs, and more. 
• No withdrawal penalties: Although you’ll have to pay standard capital gains taxes, you won’t face an additional penalty if you withdraw the funds to use for something other than higher education costs. You can use the funds for anything without a penalty attached, giving you a higher level of flexibility. 

Brokerage Account Disadvantages

Now let’s look at the downsides:

• No tax advantages: Unlike a 529 plan, a brokerage account doesn’t have any tax advantages. You’ll contribute post-tax income and the investment gains are subject to capital gains taxes. This is a significant drawback and worth considering.  

What Happens If Your Child Doesn’t Attend College?

Many families save for years in order to pay for their child’s education. But with such a long time frame, it’s hard to know what your child’s future plans might be. If your child ultimately doesn’t attend college, the impacts would play out differently in a 529 plan versus a brokerage account.

If your child opts out of college, you can transfer the funds stored in a 529 plan to another beneficiary to another family member. For example, you might transfer the funds to another child or grandchild. If you opt not to withdraw the funds instead of selecting a new beneficiary, you’ll face a 10% penalty on your withdrawal on top of standard taxes.

With a brokerage account, you have more options. Instead of using the funds for college, your child could use the funds to pay for a different life expense, such as a wedding or house. Of course, they’ll pay taxes on the withdrawals, but they won’t face an additional 10% penalty.

In either case, your child could use the funds for most educational pathways. For example, vocational schools and apprenticeship programs are covered as qualified expenses under a 529 plan. 

529 Plan vs Brokerage Account: How To Choose

529 plans and brokerage accounts are both valid ways to pay for your child’s education. The right choice varies based on your unique situation.

If you value the tax benefits of a 529 plan, it could be the right choice. But if you prefer the flexibility of a brokerage account and don’t mind missing out on some tax benefits, it could be the way to go. 

The Bottom Line

If you want to save for your child’s education, that’s a great choice! Whether you opt for a 529 plan or brokerage account, your child will thank you later.

For parents interested in opening a 529 plan, check out these top brokers.