Why I'm Mostly Saving for My Kids' College in a Brokerage Account -- Not a 529 Plan

It's a decision that gives us the most flexibility.

I started saving for my kids' college before my oldest son was born -- no joke. Granted, back when I was pregnant, I was more focused on boosting my emergency savings, but I also started socking away a small sum and investing it for education costs.

Why did I start so early on? The cost of college keeps rising and has become almost ridiculously expensive. At the same time, though, I know how important a college degree is. It can open doors career-wise and, in many cases, lead to higher earnings. And so I want to make sure that if my kids want to attend college, they're able to do so without taking on an unreasonable amount of debt in the process. 

Now when it comes to saving for college, you have choices. And many parents opt to save for college in a 529 plan. These are dedicated educational savings plans and can be used to cover not just college tuition, but also, private grade school tuition. 

The upside of funding a 529 plan is that you can invest your money and enjoy tax-free gains in your account. And withdrawals used for qualified education expenses are tax-free, too. 

Meanwhile, if you invest in a regular brokerage account, you don't get a tax break at all. Any money you make in your account is taxable, so if you start with $20,000 of your own money and that balance grows to $50,000, you'll pay capital gains taxes on $30,000. 

Despite that drawback, I'm mostly saving for my kids' college in a regular brokerage account. The reason? I want more flexibility.

The downside of 529 plans

When you save in a 529 plan, you can easily switch your account beneficiaries as needed. So, let's say you have three kids and your oldest decides they don't want to go to college. If you have $40,000 in their 529 plan, you can simply transfer $20,000 into your two other kids' 529s without any penalty whatsoever. You can even transfer that money into a niece or nephew's account if all of your kids decide college isn't for them.

But if you take a 529 plan withdrawal for non-education purposes, you'll be penalized to the tune of 10%. Now, that penalty only applies to the gains portion of your account -- not your principal contributions. But on top of that, you'll pay taxes on withdrawals taken for non-education purposes. And that's something I don't want to have to deal with.

As such, I prefer to mostly save for my kids' education in a brokerage account. That way, if all of my kids decide to bail on college, or they all get scholarships (wouldn't that be nice?), I don't have to stress about taxes and penalties (other than the usual capital gains taxes that apply). I also don't have to stress about finding a new beneficiary for those 529s should my kids not need that money for college purposes.

Explore your options

Not only are 529 plans somewhat restrictive, but you might incur costly investing fees in yours, the same way you might incur fees by saving and investing for retirement in a 401(k). With a brokerage account, I can largely avoid fees, which makes it the right choice for me. 

Now, I will say that I do have a small 529 plan for each of my kids. I figure it's not as risky a prospect to save a little money for college in these plans if the bulk of my college savings is in a brokerage account. And you may decide to go a similar route to enjoy some amount of tax savings.

Either way, if you're in the process of saving for college, don't assume a 529 is automatically the way to go. You may find that you're better off spreading your savings around or skipping the 529 altogether.