529 Plan vs. Taxable Brokerage Account: Why a Hybrid College Savings Strategy May Work Best

For decades, the 529 plan has been the undisputed heavyweight champion of education savings. The promise of tax-free growth and distributions is a powerful lure, and for many families, it is the only vehicle they consider when it comes to saving for college.

However, a growing conversation among financial planning experts—sparked by a recent Wall Street Journal article titled “The Financial Planning Expert Who’s Boycotting 529s for His Kids”—suggests that the obvious choice isn’t always the right one. One of the subjects of the article, David Blanchett, head of retirement research at Prudential Financial and formerly of Morningstar, explains his decision to skip the tax-advantaged accounts in favor of having total flexibility for his family.

Blanchett compared tax-free growth in a 529 account to the returns on his taxable account in the years before his kids go to college, and the difference was about 3%. He’s more concerned with flexibility. “We are actively saving money that we may use for college,” he says in the article. “But not necessarily.”

While Blanchett makes a compelling case for keeping his options open, we shouldn’t necessarily let the pendulum swing too far in the other direction. In my view, the tax benefits of a 529 plan are far too significant to ignore entirely. The real solution isn’t a boycott—it’s diversification. As the adage goes, you shouldn’t put all your eggs in one basket. By using a 529 for a portion of the expected costs and a taxable account for the rest, you capture the “tax alpha” while maintaining a strategic escape hatch.

No doubt, there are downsides to 529 plans. But there are also upsides.

The 529 Plan: Pros and Cons

The Pros:

• Tax-Free Growth: No taxes on dividends or capital gains while the money remains in the account.
• Tax-Free Withdrawals: If the money is used for qualified expenses (tuition, room, board, and so on), in most cases you avoid all federal and state taxes on the earnings.
• State Tax Benefits: More than 30 states offer some form of a tax deduction or tax credit.
• Estate Planning: 529s allow for “super-funding” (front-loading five years of gift-tax exclusions at once), making them a potent tool for moving wealth down generations.
• The Roth Safety Valve: Under Secure 2.0, up to $35,000 of unused funds can be rolled into the student’s Roth IRA (subject to specific age and contribution rules).

The Cons:

• The Lockup Effect: If life changes and you need that money for a noneducation emergency, you face a 10% penalty plus ordinary income tax on the earnings.
• Limited Investment Choice: You are restricted to the specific portfolios offered by the state’s plan, sometimes carrying higher underlying fees than a retail brokerage.
• The Overfunding Trap: If a child receives a full scholarship or chooses not to attend college, you may find yourself with trapped capital.

Here’s a comparison:

The Bottom Line: A Hybrid Approach Wins

For a family expecting an inheritance, or one that values the ability to shift between different life priorities, the tax drag of a brokerage account is simply the insurance premium they pay for freedom.

However, for most investors, the tax benefits of the 529 cannot be minimized. The hybrid approach of saving a conservative amount in the 529 account while supplementing with outside investments can be the optimal combination.

Financial planning is often sold as a quest for the most efficient spreadsheet. But as Blanchett’s anti-529 approach suggests, the most efficient plan on paper isn’t always the most effective plan for a family’s real-world needs. The 529 plan remains a brilliant tool, but it works best when it is part of a broader, flexible strategy.