Savings Account vs. 529: Which Should I Choose?

With the cost of tuition increasing every year, it’s never too early to start saving for college. Two accounts you can use to stash your savings in are 529 plans and savings accounts. Since a 529 plan is designed to help you pay for college, it offers different benefits than a traditional savings account. At the same time, a savings account offers more flexibility over your savings, and can be used for any purpose.

What’s the Difference Between Savings Accounts and 529s?

Purpose

A 529 plan is an investment account designed specifically to help pay for educational expenses. States, state agencies, and educational institutions offer these plan types. The two 529 plans are:

• Education savings plan: Save and invest money for qualifying educational expenses
• Prepaid tuition plan: Purchase credits at in-state universities and colleges at the current rate to use in the future. Even if rates increase, you won’t pay the difference.

A savings account at a bank or credit union is another option for saving for college, but you can also use a savings account for any purpose. You can use this deposit account for saving for a rainy day, a vacation, or a home, for example.

Investments and Returns

With a 529, you can choose different investment options. Options might include ETFs or mutual funds focused on a target enrollment year, or portfolios ranging from conservative to aggressive. A 60/40 portfolio invests 60% in stocks and 40% in bonds. Returns could go up or down based on investment type and market performance, and periods of negative returns do occur.

At an FDIC-insured bank or NCUA-insured credit union, your accounts are insured for up to $250,000. A savings account offers a set, fairly low interest rate, but the interest rate won’t bounce around like some stock prices might. Shop around for the best savings account interest rates.

Restrictions

To avoid a penalty and be able to withdraw funds tax-free, you must use a 529 plan’s money on qualifying education expenses, which include:

• College tuition and fees
• K-12 tuition and fees (up to $10,000/year)
• Student loan repayment (up to $10,000)
• Apprenticeships
• Campus housing
• Meal plans
• Books and other supplies

Unlike a 529 plan, a savings account has no restrictions on what you can spend your money on. If you change your mind later about the goal for your stash of cash, there’s no paperwork to fill out.

But banks and credit unions have requirements for savings accounts, which may include keeping a certain minimum in your account or limiting how many monthly savings transfers or withdrawals you can make. You may pay a fee if you run afoul of these restrictions—or others—so check with your financial institution.

Contribution Limits

Total contribution limits for 529 plans vary by state, but most are fairly high. The limits typically range between $235,000 and $529,000. Some plans may also have contribution minimums. In 2022, you can give up to $16,000 for the year in a 529 plan without paying gift tax to a college-bound student, or gift up to $80,000 in one year if you are treating the contribution as if will be spread over five years. Check with your tax professional for details.

Typically, traditional savings accounts don’t have contribution limits. However, some banks may have limits, and it might not make financial sense to save a huge amount in your savings account beyond your insured $250,000. Your savings account return rate likely won’t keep up with inflation, causing your savings to lose value over time.

Taxes and Fees

A 529 plan lets your savings grow tax-free, and you can make tax-free withdrawals if you use the money on qualifying educational expenses. If you use the funds on non-educational expenses, they will be subject to a 10% penalty. Some states offer additional tax credits or deductions for 529 savings plans.

A 529 plan may charge fees, which can eat into your total returns—including enrollment, maintenance, administration, and underlying fund fees. Review and compare fees for any 529 plan.

If you’re keeping your money in a traditional savings account, you’ll need to report it on your taxes at the end of the tax year. Any interest over $10 is considered taxable income, but it may or may not be enough to trigger much of a tax bill. However, your bank or credit union could charge various fees related to your savings account. Many are avoidable with some awareness and effort.

Impact on Financial Aid

Both a 529 plan and savings account can affect the amount of federal financial aid a student receives for college. Essentially, plans and accounts in a parent’s name or dependent student’s name will be factored into the financial-aid formula at a lower rate than a plan or account in an independent student’s name. Parents generally are expected to contribute a smaller portion of their assets than a student.

Which Is Right for You?

If you’re saving for college, a 529 savings plan may be a superior option to a traditional savings account, particularly if you have a while until your child heads off to college. A 529 may lead to a higher return on your investment long term, and it grows tax-free. You then can withdraw your earnings tax-free, too. A prepaid tuition plan lets you lock in tuition at today’s rates.

However, you must be confident your child will attend college in the future (or can use the funds on private K-12 education), or you could be on the hook for taxes, fees, and/or paperwork. A 529 plan also presents more restrictions than a savings account, which may not appeal to you if you want the flexibility of using your savings on non-educational expenses.

A savings account may be best if you want easy, quick access to your savings without restrictions—or perhaps need a low-risk account for this year’s tuition. If you’re not confident you’ll use the money for educational expenses, a savings account is a better option.

A Best-of-Both Worlds Option

If you’re deciding between a 529 plan and a savings account, no rule says you have to choose one or the other. It may make sense to utilize both accounts when planning for college. You could save a certain amount in a 529 plan or prepay a tuition plan to cover future costs. At the same time, you can stash some savings in your bank or credit union account.

As mentioned, however, the rate of return on a savings account could be lower than the rate of inflation, causing your savings to lose value over time. Once you’ve built up a decent emergency fund—perhaps enough to cover three to six months’ worth of living expenses—it may make sense to invest any extra savings to reap a higher return on investment.

The Bottom Line

Both 529 plans and savings accounts are designed to help you save, but a 529 plan is specifically geared toward saving for college. Because of its potentially higher return on investment (ROI) and tax perks, a 529 plan may be a smart option for a family planning for college.

At the same time, it’s always a good idea to stash some cash in a savings account, so you have the cash to draw on in an emergency or for an unexpected expense. Plus, a savings account does not restrict how you spend your money, which might appeal if your child’s future college plans are up in the air.

Frequently Asked Questions (FAQs)