529 vs. Brokerage Account: Which Is Better for College Savings?

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Brian Keaney

By Brian Keaney

June 24, 2024

Two popular college savings options are 529 plans and brokerage accounts. A brokerage account is an investment account offered by a financial institution. It allows you to buy, sell, and hold various investment assets, such as stocks, bonds, mutual funds, and other securities.

When considering investing in these, it’s crucial to understand their pros and cons. We’ll cover tax efficiency, financial aid impact, costs, investment strategies, contribution limits, withdrawal rules, state-specific considerations, and more. This will help you choose the best option for saving for college.

Tax Efficiency and Growth

Tax Benefits of 529 Plans

One of the most compelling benefits of 529 plans is their significant tax advantages. Contributions to a 529 college savings plan grow tax-deferred, and withdrawals for qualified educational expenses are always tax-free at the federal level. In most states, they are often tax-free as well. Some states also offer tax deductions or credits for contributions to their 529 plans.

Beyond these tax benefits, 529 plans also offer flexibility in using the funds. They are primarily intended for higher education expenses.

However, recent changes in federal law have expanded the use of 529 plans to include K-12 tuition, apprenticeship programs, and student loan repayment. 529 tax advantages and recent versatility make them a great option for families to start saving for college education expenses, even if you are unsure what path your child will take.

Taxation of Gains in Brokerage Accounts

On the other hand, brokerage accounts do not offer tax benefits, unlike Roth IRAs or 529 plans. When the assets in your investment account are sold, the IRS taxes the profits made as short or long-term capital gains.

Short-term capital gains are from assets sold within a year of purchase and are taxed at ordinary income tax rates. Long-term capital gains from assets held for longer than a year are taxed at the reduced rate of 15% for most individuals.

Financial Aid Implications

Impact of 529 Plans on Financial Aid

If a parent owns a 529 plan, those assets are considered parental assets, and federal financial aid calculations assess them at a maximum rate of 5.64%. When filling out a FAFSA form, 529s have a lower impact on the amount of financial aid awarded than other types of assets.

Impact of Brokerage Accounts on Financial Aid

In comparison, financial aid calculations assess assets held in the student’s name at a much higher rate of 20%. This higher assessment can reduce the financial aid a student receives.

By keeping college savings in a 529 parent-owned plan, families can minimize the impact on their Student Aid Index (SAI). A better SAI score may qualify the student for more need-based financial aid. 

Comparing Costs and Fees

Management Fees in 529 Plans

529 plans typically have management fees as low as 0.10% to 0.70% and are often lower than those of actively managed funds in brokerage accounts. It is important to look at the fee structure when choosing a plan and investment options, as they vary.

Brokerage Account Fees and Commissions

Brokerage accounts can have several types of fees, including trading commissions, management fees for mutual funds, and account maintenance fees. These fees can vary greatly. Management fees can start at 1-2% for a full-service brokerage.

While some discount brokers offer commission-free trades, actively managed funds can incur significant costs.

Risk and Investment Strategies

Common 529 Plan Investment Options

529 plans generally offer a range of investment options. Most plans offer age-based portfolios that automatically adjust. As the child gets closer to college, the investments become less risky.  This can simplify investment management for account holders. When the child is younger, the investment allocation is more aggressive. The investments automatically become less risky as the child approaches their high school graduation.

However, 529 plan investments are generally limited to a predefined selection of investment options, and not all types of investments, such as individual stocks, bonds, and certain mutual funds, are available.

Brokerage Account Investment Options

Brokerage accounts offer a wide range investment options, such as:

  • Stocks
  • Bonds
  • Mutual funds
  • ETFs
  • and more 

Some also offer non-traditional investments. While this flexibility allows you to personalize your investment approach, it also requires hands-on management and a deep understanding of the market and investment strategies to take advantage of the diverse and complex investment options.

Contribution Limits

Contribution Limits for 529 Plans

State 529 plans have high contribution limits, with New York and California each having cumulative limits of over $500,000 per beneficiary.  These high limits make 529 plans suitable for families looking to save large amounts for education.

However, if the saved money is used for non-educational expenses, the IRS imposes tax penalties when the money is withdrawn. This tax and penalty will likely cancel out any tax-free growth that occurred.

Contribution Limits for Brokerage Accounts

Brokerage accounts don’t have contribution limits. However, making contributions without the tax benefits of a 529 plan means you will owe taxes on any gains in the account. Trade commissions and capital gains taxes must be accounted for when withdrawing funds for education (or any other reason). Therefore, the actual amount available in your account may be less than your balance indicates when it’s time to pay tuition.

Withdrawal Rules and Penalties

Withdrawals from 529 Plans

Withdrawals from 529 plans are tax-free if used for qualified educational expenses. You can use those funds for tuition, fees, books, room and board, and certain other expenses. They can even be used to pay off student loans. On the other hand, income tax and a 10% penalty on the earnings apply to non-qualified distributions

Withdrawals from Brokerage Accounts

Withdrawals from brokerage accounts are not restricted, providing more flexibility. You can cay for tuition, spring break, or any other need.

State-Specific Considerations

State Tax Deductions and Credits for 529 Plans

Over 30 states offer tax deductions or credits for contributions to their 529 plans, enhancing the tax benefits. It’s important to check your state’s specific rules to maximize these benefits. Know, however, that you are not limited to just the state in which you live. You can open a 529 plan in any state that offers one. However, most states require you to use the in-state 529 plan to be eligible for a tax credit.

Uniform Laws and Regulations for Brokerage Accounts

While there are federal regulations for brokerage accounts, there are no state tax benefits for education savings.

Evaluating the Upsides and Downsides

Advantages of 529 Plans

  • Tax-free growth and withdrawals for qualified educational expenses
  • Potential state tax deductions or credits
  • Low impact on financial aid eligibility
  • High contribution limits

Disadvantages of 529 College Savings Plans

  • Funds must be used for qualified educational expenses to avoid penalties
  • Limited investment options compared to brokerage accounts

Advantages of Brokerage Accounts

  • No restrictions on withdrawals
  • Broad range of investment options
  • No specific contribution limits

Disadvantages of Brokerage Accounts

  • Investment gains are subject to capital gains taxes
  • Higher impact on financial aid eligibility

Making the Right Choice for Your Child’s Education

When deciding between a 529 college savings plan and a brokerage account, consider your financial situation, goals, and risk tolerance. If tax advantages and minimizing financial aid impact are important to you, a 529 plan is the better choice.

A good place to start:

See the best 529 plans, personalized for you