Tax advantages of using 529 plans to save for child's education?
There are several variables to consider. Taxes, fees, returns. Taxes come in two stages. While adding money to the account you can save on state taxes, if the account is linked to your state. If you use an out of state 529 plan there is no tax savings. Keep in mind that other people (such as grandparents) can set aside money in the 529 plan. $1500 a year with 6% state taxes, saves you $90 in state taxes a year. The second place it saves you taxes is that the earnings, if they are used for educational purposes are tax free. You don't pay taxes on the gains during the 10+ years the account exists. If those expenses meet the IRS guidelines they will never be taxed.  It does get tricky because you can't double dip on expenses. A dollar from the 529 plan can't be used to pay for an expenses that will be claimed as part of the education tax credit. How those rules will change in the next 18 years is unknown. Fees: They are harder to guess what will happen over the decades. As a whole 401(k) programs have had to become more transparent regarding their fees. I hope the same will be true for the state run 529 programs.  Returns: One option in many (all?) plans is an automatic change in risk as the child gets closer to college. A newborn will be all stock, a high school senior will be all bonds. Many (all?) also allow you to opt out of the automatic risk shift, though they will limit the number of times you can switch the option. Time horizon Making a decision that will impact numbers 18 years from now is hard to gauge. Laws and rules may change. The existence of tax breaks and their rules are hard to predict. But one area you can consider is that if you move states you can roll over the money into a new account, or create a second account in the new state. to take advantage of the tax breaks there.  There are also rules regarding transferring of funds to another person, the impact of scholarships, and attending schools like the service academies. The tax breaks at deposit are important but the returns can be significant. And the ability shelter them in the 529 is very important.
I know it isn't exactly the question you asked, but please consider your future too. 529 is the correct answer, because if you can fund a Roth, you should be funding it for your own retirement. Your retirement has much a higher priority over anybody's college fund.  It is pretty great that you want to set aside cash for the niece's education, I think asking which vehicle is best for saving for education might be the wrong question. Students have many options for going to school and paying for it but retirement is pretty limited. http://www.clarkhoward.com/news/clark-howard/education/clarks-529-guide/nFZS/ is a good place to learn about 529s and makes good suggestions on where to get one.  Do it yourself, and don't pay a broker or agent to do it for you. If your retirement is already handled, feel free to vote me down and I will delete this. Group RESPs are a bit like a true mutual insurance company. You all pay into the fund, and then, depending on the number of kids that are in school that particular year, you get paid a certain amount. Advantages could be that if you end up with one or two years of only your kid in school and nobody else's in that age bracket, you get more money. Disadvantage for the same-reverse reason also could be true. Another advantage of regular programs, unlike pooled, is that if you do not use all the money, then some/all of the remaining funds may be transferable to an RRSP. Personally I would not invest in one, unless it was more like a specific investment-club that I knew everybody. While not entirely untouchable, a college fund can also be in the form of an Indexed Universal Life (IUL) contract through a life insurance agent.  These often net a higher rate of return annually than any savings account, are not going to tank if the market does, and can be owned by you for the child.  If no one else is on the policy, they have no access to it.  You can name yourself the beneficiary as well.  There's several very nice features to doing your child's college funding this way. You can ask that the contract is established for maximum cash value.  This means the death benefit isn't the overriding need so the premiums you pay fill the cash value of the contract much more quickly. As mentioned in point 1., the contract has a death benefit.  No other savings device will grant you this.  Heaven forbid the child passes while you are saving for college.  Now you will have a tax free benefit that will pay for burial and other related costs and can be used to fund yet another IUL policy if you have more than one child. Unlike other policies, you can set your minimum monthly premium and have the flexibility to add as much as you would like to fill the fund faster if you happen to come into more money and you want to direct it to that contract.  There are ceilings to this so that you don't create a modified endowment contract (MEC. Look this up at investopedia), but this is specifically stated in your illustration so that you can keep your contributions a penny under that limit. Unlike college loans, you have extremely quick access to the funds when you need them (probably counter-intuitive to your desire for untouchable money). This can be achieved a couple of ways.  You can borrow money from the insurer using your IUL cash value as collateral.  Often, a check can be cut within 48 hours.  This eliminates the time a normal lender takes in making the loan decision.  Or, you can surrender the policy and take the cash value (paying taxes on your gains).  The first keeps the policy in force while you pay back the loan if you desire.  The second cancels the policy so that you can take your own accumulated money out. Utilizing an IUL in this manner can (but not always) lower your Expected Family Contribution (EFC) with colleges so that you could qualify for higher student aid.  If your income puts you in the middle class, you would be wise to note this in particular.  Having control over your EFC is major benefit.  (If you'll read the link above, you notice the UGMA isn't necessarily the best idea as schools look to the student to give a higher percentage of their own assets than the parent.) Ultimately, while the IUL is a little known method for saving for college (and some will argue what they may) it would benefit you to speak with an insurance professional about this option.  Ask if the insurer has access to the SAGE Rewards program (https://secure.tuitionrewards.com/).  The program is a free benefit if you purchase a cash value contract like an Indexed Universal Life policy and activates IF the agency participates.  The child earns tuition credits for every birthday of your child (not retroactive) and for having the policy.  If you do an annual review, you earn more tuition credits.  I have established these for clients and some have sent their child to college with more than 44k in college funding (split out over four years).  The point system is 1 credit = 1 tuition dollar.  Quite unlike air miles! For those of you reading this that have similar concerns, please consult an with an agent (or feel free to contact me) to get up to date advice on how to structure these.  They are simple and efficient and have significant upside for college funding. I was in a similar situation with my now 6 year old.  So I'll share what I chose.  Like you, I was already funding a 529. So I opened a custodial brokerage account with Fidelity and chose to invest in very low expense index fund ETFs which are sponsored by Fidelity, so there are no commissions.  The index funds have a low turnover as well, so they tend to be minimal on capital gains. As mentioned in the other answer, CDs aren't paying anything right now.  And given your long time to grow, investing in the stock market is a decent bet. However, I would steer clear of any insurance products.  They tend to be heavy on fees and low on returns.  Insurance is for insuring something not for investing. Dazed, an RESP is a type of account.  Within the RESP, you can have cash, investments or even savings vehicles like GICs etc.  So depending on where you put the money within the RESP, yes, there is a chance of losing money. If you think your children will attend post secondary education, I don't think that there is a better way to save.  The government will match 20% of your contribution, up to a maximum grant of $500 per year. To take advantage of the grant, we contribute $2500 per year to obtain the maximum $500 grant. Hope this helps! The point is to provide for yourself in retirement, so it makes sense that these withdrawals would be penalized. Tax deferred accounts are usually created for a specific cause. Using them outside of the scope of that cause triggers penalties. You mentioned 401(k) and IRA that have age limitations because they're geared towards retirement. In the US, here are other types, and if you intend to spend money in the related areas, they may be worth considering. Otherwise, you'll hit penalties as well. Examples: HSA - Health Savings Account allows saving pre-tax contributions and gains towards medical expenses. You must have a high deductible health plan to be eligible. Can be used as IRA once retired. 529 plans - allow saving pre-tax gains (and in some states pre-tax contributions) for education expenses for you or a beneficiary. If a beneficiary - contributions are considered a gift. There's a tax benefit in long term investing in a regular taxable brokerage accounts - long term capital gains are taxed at a preferable (lower) rate than short term or ordinary income. The difference may be significant. Long term = 1+ year holding. The condition here is holding an investment for more than a year, and there's no penalty for not satisfying it but there's a reward (lower rates) if you do. At the very least you should invest as much as you can that your employer will match, as they are basically giving you free money for saving. After that I would prioritize a Roth IRA as that offers similar tax benefits with more liquidity. Provided you have enough money available in your emergency fund and have plenty for everyday expenses I see no reason not to max out your 401k after that if you can afford it. However, if your emergency fund is lacking, be sure to put some there. Other investments like a 529 may come into play if you have kids you plan on sending to college, but it all depends on your situation. First, can I even roll any my profits into a 529 plan to avoid taxes. No. 529 plans are not pre-tax (except for State taxes in certain States, where 529 contributions are deductible. Ohio is such a State, with certain conditions). For Federal taxes - funding a 529 with yourself as a beneficiary doesn't change a thing on your taxes. Is there any special requirements for the state of Ohio. Yes, see the link above. Essentially you'll be carrying the deduction forward for years until you exhaust it, $2000 at a time. Is there a better solution that I am overlooking. No. If it was easy to avoid income taxes - everyone would be doing it. Some states will give you a tax deduction for 529 contributions. This will allow some tax savings for money that spends a minimum amount of time in the account.  Yes you have missed the best benefit, the tax free growth, but there might be an opportunity for some growth. The child's expenses beyond tuition can be covered by 529 plan. It can even cover room and board if they are living in the dorms, off campus apartment, or even at home. Each University through their financial aid office will calculate the total cost of attendance for each student type. Before doing this you need to look at several things: "I'm in a similar situation. First, a 529 plan can be use for ""qualifying"" international schools.  There are 336 for 2015, which includes many well known schools but also excludes many schools, especially lower level or vocational schools and schools in non-English speaking countries. I ran 3 scenarios to see what the impact would be if you invested $3000 a year for 14 years in something tracking the S&P 500 Index: For each of these scenarios, I considered 3 cases: a state with 0% income tax, a state with the median income tax rate of 6% for the 25% tax bracket, and California with an income tax rate of 9.3% for the 25% tax bracket. California has an addition 2.5% penalty on unqualified distributions.  Additionally, tax deductions taken on contributions that are part of unqualified distributions will be viewed as income and that portion of the distribution will be taxed as such at the state level. Vanguard's 500 Index Portfolio has a 10 year average return of 7.63%.  Vanguard's S&P 500 Index fund has a 10 year average return of 7.89% before tax and 7.53% after taxes on distributions. Use a 529 as intended: Use a 529 but do not use as intended: Invest in a S&P 500 Index fund in a taxable account: Given similar investment options, using a 529 fund for something other than education is much worse than having an investment in a mutual fund in a taxable account, but there's also a clear advantage to using a 529 if you know with certainty you can use it for qualified expenses.  Both the benefits for correct use of a 529 and the penalties for incorrect use increase with state tax rates. I live in a state with no income tax so the taxable mutual fund option is closer to the middle between correct and incorrect use of a 529.  I am leaning towards the investment in a taxable account." When I think of the loopholes that the richest of the rich exploit to get out of paying taxes, this article does seem kind of pointless.  Why attack the 529 plan?  It would be better to attack the expense of the education and the need for the plan in the first place.  Upper middle classers shouldn't have to give a second thought to how much it will cost to send their kids to university, unless it is a private school.  30 years ago it cost 350 bucks for a semester.  Now it is 10k or more.  We all see that this is ridiculous, but it goes on and on.  Rents have doubled or even tripled in the last 7 years and this is normal? "Others have given some good answers. I'd just like to chime in with one more option: treasury I-series bonds. They're linked to an inflation component, so they won't lose value (in theory). You can file tax returns for your children ""paying"" taxes (usually 0) on the interest while they're minors, so they appreciate tax-free until they're 18. Some of my relatives have given my children money, and I've invested it this way. Alternatively, you can buy the I-bonds in your own name. Then if you cash them out for your kids' education, the interest is tax-free; but if you cash them out for your own use, you do have to pay taxes on the interest." Nice idea, but you will have a potential problem. State lawmakers have already considered this option: I looked at this site: Saving for college because it include info for on all the plans. For Illinois it discuses income tax recapture. Effective January 1, 2007, rollovers from this plan to an out-of-state   program are included in Illinois taxable income to the extent of prior   Illinois deductions. Effective January 1, 2009, nonqualified   distributions from this plan are included in Illinois taxable income   to the extent of prior Illinois deductions. Most of the states have similar wording. When looking up the law the key word is recapture. The reason why there is no recapture provision at the federal level is that there is no tax deduction on contributions. The 10% penalty make it less likely that somebody would want to have nonqualified distributions. If a state gives a tax deduction in the year of the contribution they want to demand that tax deduction back if the funds are not used for educational purposes. Generally there are of course provisions for scholarships, death, and disability. "The 529 plan does outline your scenarios. There are stipulations for providing the funds should the child get the scholarship. If the child decides not to go into further education (vocational and community schools count), the money can be withdrawn with a 10% penalty and taxes paid on interest earnings. Taxes wouldn't have to be paid for contributions as taxes were already paid on that money by the gift giver. The 529 could also be transferred to another child in the family (including grandchildren).  Here's an excerpt from www.savingforcollege.com: You'll never lose all of your savings. A 529 plan offers tax-free earnings and tax-free withdrawals as long as the money is used to pay   for college. If you end up taking a non-qualified withdrawal, you'll   incur income tax as well as a 10% penalty - but only on the earnings   portion of the withdrawal. Since your contributions were made with   after-tax money, they will never be taxed or penalized. You can avoid the penalty if you get a scholarship. There are a few special exceptions to the 10% penalty rule, including when the   beneficiary becomes incapacitated, attends a U.S. Military Academy or   gets a scholarship. In the case of a scholarship, non-qualified   withdrawals up to the amount of the tax-free scholarship can be taken   out penalty-free, but you'll have to pay income tax on the earnings.   As Savingforcollege.com founder Joe Hurley likes to say, ""the   scholarships have turned your tax-free 529 investment into a   tax-deferred 529 investment"". Note, a 529 is ideal for the sum of money you are looking at. A proper trust, set up by a lawyer, will cost as much as $2000 to set up, and would require an annual tax return, both unnecessary burdens. To make matters worse, the trust counts as the child's asset where financial aid is concerned. The 529 counts, but to a much lesser extent." Saving for college you have a couple of options.  529 plans are probably the best bet for most people wanting to save for their kids college education. You can put a lot of money away ~$300k and you may get a state tax deduction. The downside is if you're kid doesn't go to college you may end up eating the 10% penalty. State specific prepaid tuition plans. The upside is you know roughly the return you are going to get on your money. The downside is your kid has to go to a state school in the state you prepaid or there are likely withdrawal penalties. For the most part these really aren't that great of a deal any more.  ESAs are also an option but they only allow you to contribute $2k/year, but you have more investment options than with the 529 plans. Traditional and ROTH IRA accounts can also be used to pay for higher education. I wouldn't recommend this route in general but if you maxed out your 401k and weren't using your IRA contribution limits you could put extra money here and get more or really different flexibility than you can with a 529 account. I doubt IRA's will ever be asked for on a FAFSA which might be helpful. Another option is to save the money in a regular brokerage account. You would have more flexibility, but lower returns after taxes. One advantage to this route is if you think your kid might be borderline for financial aid a year or two before he starts college you could move this money into another investment that doesn't matter for financial aid purposes. A few words of caution, make sure you save for retirement before saving for your kids college. He can always get loans to pay for school but no one is going to give you a loan to pay for your retirement. Also be cautious with the amount of money you give your adult child, studies have shown that the more money that parents give their adult children the less successful they are compared to their peers.