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529 Plan vs. Savings Account


College can be one of the biggest expenses you might have to plan for as a parent, after buying a home and funding your retirement. If you have room in your budget to save for college, it’s important to choose the right place to keep your money. You could open a regular savings account at your bank but a 529 college account could yield more benefits. It’s helpful to know what’s different about a 529 vs. savings account when deciding where to save. You can speak with a financial advisor directly who can help you learn more or dive into the choice of which might be best for your financial goals.

What Is a 529 Plan and How Does It Work?

A 529 college savings account is a tax-advantaged account that you can use to save for college. You can open a 529 savings account on behalf of a designated beneficiary, which can be your child, your spouse or even yourself. The money saved in the account can be used to pay for qualified education expenses.

The federal government doesn’t offer a tax deduction for 529 plan contributions, though they do grow on a tax-deferred basis. And you can get another tax break when it’s time to withdraw the money. Distributions are tax-free when they’re used for qualified education expenses, including:

  • Tuition and fees
  • Required books, supplies and equipment
  • Room and board for students enrolled at least half-time
  • Computers, software and internet access
  • Expenses for students with special needs
  • Expenses related to a certified apprenticeship program

You can also withdraw up to $10,000 per year to pay tuition at eligible private, religious or public primary and secondary schools. And the IRS now allows you to use up to $10,000 to pay qualified education loans taken out by the designated beneficiary.

If your designated beneficiary doesn’t go to college, you can transfer money in a 529 account to a new beneficiary. There’s no deadline for using the money in your account so you can keep rolling the money over to new beneficiaries without a tax penalty, but the money can’t be used on anything other than educational expenses unless you will be on the hook for federal income tax and a 10% penalty.

What Is a Savings Account and How Does It Work?

A savings account is a type of demand deposit account that you can use to set aside money for future goals. Traditional banks, online banks and credit unions can offer savings accounts. Where you open a savings account can determine the interest rate you earn on deposits, the fees you pay and your options for accessing the money.

Savings accounts are safe and secure, with virtually zero risk of losing money. The FDIC insures savings accounts at member banks up to $250,000 per depositor, per account ownership type and per financial institution. So even if your bank fails that doesn’t mean your savings will disappear. The National Credit Union Administration insures savings accounts at member credit unions.

When you open a savings account, you might need to make a minimum opening deposit. Once your account is open, you can continue depositing money to grow your savings. You can withdraw money as needed, though your bank might cap you to a certain number of withdrawals per month. If you go over that limit, the bank can impose an excess withdrawal fee.

529 vs. Savings Account: Which Is Better?

529 vs savings account

A 529 college savings account can offer some advantages that you might miss out on with a regular savings account. The main benefits of a 529 plan over a savings account include:

  • Tax-deferred growth
  • Tax-free withdrawals for qualified education expenses
  • More growth potential

When you add money to a 529 savings plan, you can invest it in mutual funds, exchange-traded funds (ETFs) or target-date funds. Because you’re investing money in the market, there’s more room for it to grow compared to a savings account that’s earning a lower interest rate. Of course, you also risk losing money since the value of your 529 account is directly tied to the value of your underlying investments.

It’s also important to keep contribution rules and limits in mind. All 50 states offer at least one 529 college savings account and you can contribute to any state’s plan, regardless of where you live. But there can be different caps on lifetime contribution limits to each plan. Additionally, you also have to be mindful of gift tax exclusion limits.

When you make financial gifts to someone, including 529 plan contributions, gift tax can apply if the amount exceeds the annual exclusion limit. For 2022, that limit is $16,000, doubling to $32,000 for married couples who file a joint return and agree to split gifts. So if you’re married and have three kids, for example, you and your spouse could contribute $32,000 to a 529 plan for each of your kids for the year without triggering the gift tax.

Regular savings accounts aren’t subject to any of those rules. You can open a savings account at a local bank or online and earn interest at a rate set by the bank. Your money isn’t invested and there are no caps on how much you can deposit to savings, though there is a limit to how much of your savings the FDIC insures.

You also don’t have to worry about the gift tax as long as any money you withdraw from a savings account is used to pay college costs to the school directly. However, if you were to take money from a savings account and give it to your child to pay for school that would constitute a gift. You can also use the money in your savings account for other expenses that aren’t qualified educational expenses, which is a benefit.

Should I Open a 529 Plan or a Savings Account?

The right choice depends on your personal financial situation and what goals you have for saving or growing your money. When deciding how to save for college, it’s important to remember that it doesn’t have to be either/or. You could open and contribute to a 529 college savings account to get some tax breaks and steady growth. And you can keep money in a regular savings account as a backup.

For example, say your child plans to live off-campus while attending school less than half-time. In that case, you wouldn’t be able to use 529 savings to pay for housing expenses. But you could take money from a savings account and use it to cover their rent for the lease term. As long as you’re within the annual gift tax exclusion limit, you wouldn’t have to worry about gift tax.

If you’re considering a 529 college savings account, take time to compare plans offered in your state and in other states. Specifically, consider the range of investment options offered, the fees that apply to those investments and lifetime contribution limits.

When opening a savings account, it’s important to look at the interest rate you could earn and the fees the bank charges. Traditional banks tend to offer lower rates and charge more in fees compared to online banks. So it may be worthwhile to consider a high-yield savings account to supplement a 529 savings plan.

The Bottom Line

529 vs savings account

If you’re ready to get a jump on college savings, a 529 plan and a savings account can help with achieving your goals. With 529 plans, it’s important to be aware of the tax rules that apply when it’s time to withdraw the money so you don’t end up with a surprise tax bill. Shopping around can help you find the 529 plan and the savings account that best fit your needs.

Tips for Savings

  • Consider talking to your financial advisor about whether to use a 529 vs. savings account for college planning. If you don’t have a financial advisor yet, finding one doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • In addition to a 529 plan or savings account, you could also save for college using a Coverdell Education Savings Account (ESA). With this type of account, you can contribute up to $2,000 per year, per beneficiary until they reach age 18. Withdrawals for qualified education expenses are tax-free, but there’s a catch. All of the money in the account must be withdrawn by the time the beneficiary reaches age 30. Otherwise, a steep 50% tax penalty applies.

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