What’s the best way to save for college?

Just like there are different ways to save for retirement, there are different ways to save for college. While 529 plan accounts generally offer the most tax advantages for saving for higher education, each savings option has pros and cons.

529 college savings plans

529 plan accounts are specifically designed to help investors save for higher education—offering tax benefits,* a variety of investment choices, and the flexibility to change beneficiaries (to an eligible family member of the original beneficiary).

However, the earnings in a 529 plan account will be subject to federal income tax, state and local income tax, and a 10% penalty tax if they're not used for qualified higher-education expenses.

UGMA/UTMA accounts

Custodial accounts under the Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) allow you to save on behalf of a minor for education or any other purpose that benefits the minor (other than parental obligations like food, clothing, and shelter).

Contributions to an UGMA or UTMA are irrevocable. The beneficiary on the account can take ownership of the assets as soon as he or she reaches the age of majority (between ages 18 and 21, depending on the state). And because the assets in an UGMA/UTMA belong to the beneficiary, the beneficiary can never be changed.

Taxable accounts

Taxable (nonretirement) accounts, like checking or savings accounts and individual or joint investment accounts, give the account owner complete ownership of the account assets. Only adults can register for account ownership.

Taxable accounts have no contribution limit and no rules regarding what the assets can be used for, but there are no tax advantages for using the assets for educational expenses.

Tips on choosing your investments

Whichever account you use to save for your child's education, it's important to choose the right investments to help you reach your goals. The combination of stocks, bonds, and cash you choose—your asset allocation—will impact your investment returns and how your portfolio reacts to market ups and downs.

Trying to avoid market risk (the likelihood your investments will lose value with market movement) by holding only lower-risk investments such as money market and bond funds or CDs can expose you to other types of risk, like being unable to outpace inflation or reach your goals.

Diversification is a good way to manage many types of risk. Owning a portfolio that gives you "a little bit of everything" can balance out your exposure to both strong- and weak-performing areas of the market.