We consulted financial experts to determine if 529 plans are indeed the optimal choice for saving for children's college expenses.

College is a significant choice for both teens and their parents. Rhiannon Schade, a college counselor, saves for her two-year-old daughter but has opted against a 529 college savings plan due to her daughter's rare condition, which might impact her educational journey.

“As a college counselor, I thought a 529 would be a given for us,” Schade explains. “After discovering my daughter's condition, I had to rethink what saving for her future means. She may choose college or another path, and I want to support her decisions.”

Schade represents many parents reconsidering the value of a 529 plan for future savings. Although her situation is unique, many parents hesitate to commit funds to a plan solely meant for education. Concerns about locking away money based on the assumption their child will attend college are common. Others believe their children might benefit more from unrestricted cash, while some anticipate that free tuition programs will emerge by the time their children enroll.

We asked financial experts if 529 plans are genuinely the best savings strategy for children. Their insights follow:

Understanding 529 College Savings Plans

A 529 plan is a tax-advantaged savings vehicle designed for future college costs. The primary drawback, according to many, is that funds in 529 plans are limited to educational use. If utilized for non-educational purposes, taxes and penalties apply.

“If the assets in a 529 plan are not spent on qualified education expenses because the child doesn’t attend or finish college, or if the full amount isn't used, the benefits become fully taxable along with an additional 10 percent IRS penalty,” notes Tyler Boling, a financial advisor from Connecticut. “Contributors may also need to return any tax deductions they received when contributing to the plan.”

What If Your Child Chooses Not to Attend College?

Experts emphasize that while 529 funds are designated for education, there are avenues to use the money without incurring penalties, even if the beneficiary opts out of college.

“The positive aspect is that the account beneficiary can be changed,” says Kristen Moon, owner of a college prep service in Atlanta. “Funds can be transferred to a sibling or even used by a parent who decides to return to school, as long as the money is applied to qualifying educational expenses.”

If no children in a family attend college, funds can ultimately be designated for a grandchild.

Ted Jenkin, a certified financial planner, shared that he allocated funds to his kids' 529s with beneficiary flexibility in mind. “I provided the most funding to my eldest, ensuring that whatever she didn’t utilize could be allocated to my younger children.”

Exploring Alternative Savings Options

While 529 plans can be adjusted within families, they may not be ideal if free tuition becomes commonplace in the coming years, as some speculate. Because of this uncertainty, some parents prefer to avoid 529 accounts altogether.

They might consider a Roth IRA instead, which offers the advantage of being uncounted in financial aid assessments by colleges.

“A Roth IRA serves as an excellent alternative to a 529 plan since contributions are made after tax and can be accessed anytime without penalties,” Boling explains. “If the child does attend college, parents can withdraw contributions to help fund their education without affecting the expected family contribution. If college isn’t on the horizon, parents retain the assets in a retirement account without the constraints of a 529 plan.”

It’s important to remember that while there’s no penalty for using Roth IRA funds for education costs, income taxes will still apply to any portion of the distribution subject to income tax.

Another option is a custodial account, known as a UGMA account, which allows minors to hold assets. However, Richard Barnes, a tax professor, argues these accounts have become less appealing due to better investment choices.

“UGMA accounts have lost most of their previous allure,” he states.

Final Thoughts

Deciding whether to establish a 529 account or pursue alternative savings methods is ultimately a choice for you, your partner, and your financial advisor. However, Barnes highlights that 529 plans offer a significant benefit: tax deferral.

“CPAs and attorneys often mention that ‘a tax deferred is a tax destroyed,’” he explains. “Money saved now or today is more valuable than future earnings. This concept, known as the ‘time value of money,’ emphasizes the advantage of investing in a 529 plan and deferring income tax on gains until withdrawal. If 529 proceeds go to qualifying education expenses, income tax on those gains is entirely avoided. If not used for educational costs, you’ll owe taxes on the profits later.”

This is a crucial benefit of 529 plans that often goes unnoticed.

“When planning, consumers frequently emphasize immediate tax benefits from tax-related moves — such as contributing to a traditional 401(k) to avoid paying taxes today — but that’s only part of the tax benefit, often overshadowed by the deferred tax on earnings.”