Financial experts advise parents to start saving early for college by opening a 529 or savings account. The best time to do this is before their child is in high school.

College tuition by itself is exorbitant. Add to it the other costs of books, accommodation, food and other expenses and it can be unaffordable for most families in America. Students often end up taking thousands of dollars in student loans to cover the total cost of attendance. One way to reduce the total amount of student loan debt is by saving money specifically for the purpose of higher education. 529 and savings account are two of the best ways to get started.

Don’t know the difference between 529 plan vs savings account? Or not sure which is better? Understanding how they work and the pros and cons of 529 vs savings account is the first step. This will help you make an informed decision about which one is best for you.

What is a 529 plan? How does it work?

A 529 plan is a type of tax-advantage college savings account. It works as a credit system that will be applied to your child’s future tuition. The name refers to the chunk of the Internal Revenue Code they sprung from, Section 529. The specifics of these plans vary from state to state, although the basics remain about the same.

Anyone can open a 529 savings account on behalf of a designated beneficiary. For example, you can open an account on behalf of your child or spouse or even yourself. The growth of the funds is based heavily on the performance of the financial market. This means that the fluctuation of several factors – including the federal and local economy – plays a role in pricing.

The funds in a 529 account can be used to pay for qualified education expenses. This includes tuition, fees, text books, room and board, school supplies, computers, software, and internet access. The funds can also be used to cover additional expenses for students with special needs.

529 plan contributions grow on a tax-deferred basis. You also get a tax break if the funds are used for qualified expenses. You will pay federal income tax and a 10% penalty if the funds are used for ‘unqualified’ expenses.

If the designated beneficiary of a 529 account decides against going to college, the funds can be transferred to another beneficiary. All other terms and conditions remain the same.

What is a savings account? How does it work?

A savings account is essentially a deposit account that you can open at any bank or credit union. Anytime you have extra cash, you can deposit it into your savings account. Whatever cash is deposited into a savings account earns interest every month. Some banks may have a minimum balance you’re required to keep in your savings account.

You can continue depositing money into your savings account to grow your savings. Although the money grows relatively slowly in such an account, you know it’s safe and secure. Moreover you can withdraw up to the balance in the account anytime you need it and use it for any purpose. There are no restrictions as to the withdrawal amounts or what you use the money for. However, you cannot withdraw more than your balance.

Pros and cons of 529 plan vs savings account

Offered around the country, 529 plans are nearly synonymous with college payment accounts. They are probably the most popular option for parents who value advantages in taxes when saving money.

• A 529 savings plan is more straightforward. In this option, you’ll deposit money, starting with as little as $20 over the years until you reach a hard cap. The cap changes depending on your state but is usually between $300,000 and $500,000. 529 savings plans include built-in tax benefits and scholarship opportunities due to their unique execution.
• 529 plans remain an extremely popular option, with well over 12 million individual accounts open nationwide as of last year. For more information, check out your state’s Direct Plan website to find out how to add your name to the list.
• The only downside is that you can’t use the money for any purpose other than educational expenses.

Pros and cons of savings accounts

• Savings accounts offer more flexibility than 529 accounts. You can open a savings account at any traditional or online bank or at any credit union.
• Another major advantage of savings account is that you can use money in a private savings account for anything, at any time. In case of a financial emergency, the funds in the private account can be reallocated to meet more pressing needs. There are no restrictions as to what you can use the funds for.
• The only downside of savings accounts is that money in these accounts grows very slowly.

So which is better – 529 or savings plan?  

Neither one is better across the board. The winner of the 529 plan vs savings account debate depends on your financial circumstances and long term goals. While 529 plans are popular for their tax breaks and concrete certainty, savings plans are also a great option for their flexibility and security. There are great arguments on both sides, and the pros and cons to each.

Take some time and weigh the pros and cons of both 529 and savings plans before deciding which is the better option for you.

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