Updated: Dec 27, 2022
There are several vehicles for education savings available to families. While there are pros and cons to each of them, on balance 529 plans are the best of the bunch. Here are the reasons why.
The biggest advantage a 529 plan has over the competition are its tax features. Earnings on funds invested in a 529 plan are tax-free when used for qualified education expenses. And most states provide an income tax deduction or credit for contributions to a 529 plan.
Contributions to a 529 plan, Coverdell Education Savings Account (ESA), and a Uniform Gift/Transfer to Minors Act (UGMA/UTMA) account are gifts to the beneficiary subject to the annual exclusion ($16K per beneficiary for 2022). But only 529 plans allow the “front-loading” of up to five years of annual exclusion gifts. So for 2022, up to $80K ($160K for joint filers) may be contributed to a 529 account without gift tax consequences, thereby allowing more time for tax-free growth.
Unlike Coverdell ESAs and Roth IRAs, there are no income phase-outs or annual contribution limits when saving in a 529 account. Although each 529 plan has a maximum total contribution limit, the ceiling for each plan is quite high. Finally, 529 plan investments usually receive favorable treatment when applying for financial aid using the Free Application for Federal Student Aid (FAFSA). Typically, a 529 account is owned by a dependent student or his or her parents which minimizes the impact on eligibility for needs-based financial aid.
A more detailed comparison of these savings vehicles is provided in the table below.