Saving for college can be a daunting task. And with tuition costs going up, investing is one of the best ways to grow your wealth in a tax-advantaged account.
One type of account some parents turn to is 529. With a 529 plan, it’s possible to invest money so that it grows and helps cover college costs. When your child needs the money for school, they can withdraw the earnings tax-free to pay their qualified expenses.
But what about adding crypto to a 529 plan? Let’s take a look at including crypto in your college savings approach and what your options are.
What Is A 529 Plan?
A 529 plan is a tax-advantaged account that people use to help save for higher education for a beneficiary, which is generally one's child or grandchild.
With a 529, you set money aside in the account and then choose investments designed to help the money grow. There’s no federal tax deduction for the money you put into a 529, but some states offer state tax deductions or credits when you contribute to a 529. The money grows tax-free as long as it’s used for qualified education expenses later on.
In many cases, a 529 is a state-sponsored plan. You don’t have to live in a state to take advantage of a plan in some cases, so it might not matter where you live if you want to take advantage of the possibility of using a 529 for saving.
Typically, investment choices in a 529 plan are index products. But you might be wondering: can you invest in cryptocurrency with your 529 plan instead?
Can You Hold Crypto In A 529 Plan?
For the most part, you’re limited to what investments are available in your 529 plan. You likely won’t be able to add crypto to your 529 plan account, unless you add an ETF that offers exposure to blockchain companies to your account — as long as the shares are available through the 529 account.
The good news is ETFs like the Grayscale Bitcoin Trust and Grayscale Ethereum Trust help give investors exposure to Bitcoin and Ethereum without actually investing directly into the coins. But again, you need to have these shares available through your 529 account.
Ultimately, this means if you want to add crypto to a portfolio designed for college savings, you likely need to use alternative methods.
How To Use Crypto To Save For College
Because getting crypto into a 529 plan is almost impossible, you might have to use other methods to include crypto in a college savings portfolio.
Here are some ways you can use crypto for your child’s college account.
Use A Coverdell ESA
One way to add crypto to a college savings portfolio is with a Coverdell Education Savings Account. You have to take extra steps to open a Coverdell ESA for crypto, however.
When you use a Coverdell, you first have to find a custodian who will help you manage the account. For example, you might need to use Directed IRA and open a Crypto ESA. Then, the custodian helps you open an account with a cryptocurrency exchange like Gemini. This is similar to the process you’d follow if you want to hold crypto in a Health Savings Account or IRA.
These self-directed accounts allow you to use a crypto account for ESA college savings purposes. If you already have an exchange account, though, you need a separate account for your ESA. Any earnings you receive from the crypto are held in the trading account and can be used later for qualified costs.
Carefully check the fees, however. Often, there’s a setup fee for these types of arrangements, plus an annual fee. The trading fees when you transact business in the account can also add up. Before you take this approach, double-check to ensure that gains are likely to outweigh the fees.
UTMA & UGMA Plans
A Uniform Transfer to Minors Act (UTMA) or Uniform Gift to Minors Act (UGMA) account can be another way to save for college using crypto. In this type of account, you set up a custodial arrangement and then hold crypto in the account on behalf of your child. Later, the account is transferred to your child when they reach a certain age.
Some companies, like UNest, offer these plans so parents can get their kids to invest before they go to college. UNest offers cryptocurrency and non-fungible token (NFT) choices in their accounts, along with more standard fare, like funds and individual equities.
EarlyBird is another company that offers college savings opportunities that involve cryptocurrency. With EarlyBird, a UGMA account, you can ask friends and family to contribute and help you build an account. Then, you can use the money to invest in cryptocurrency on behalf of your future student.
However, it’s important to note that income from a UTMA or UGMA account is only tax-free up to a certain point, and then a portion is taxed at the child’s tax rate and the rest taxed at the parent’s rate. Depending on the company you use, you might be able to get someone to manage a portfolio on behalf of your child.
Realize, though, that a UTMA account can have a significant impact on your child’s financial aid, so weigh that carefully before you invest cryptocurrency.
Taxable Account For Crypto
Finally, it’s also possible to just open an account for yourself and grow crypto as a way to accumulate money that you can use later to pay for your child’s college costs.
There are many crypto exchanges like Coinbase or Binance that you can use to start investing. Many stock brokers also let you invest in digital assets. In fact, you can invest in crypto with $100 or even less and slowly build up your crypto nest egg over time.
And this is just the tip of the iceberg for what's possible. You can also use decentralized finance (DeFi) tools like crypto savings accounts to earn passive income with crypto. These accounts let you earn a very high APY, depending on the exchange you use or the project you’re involved with.
However, any crypto assets you have will be used to determine the Expected Family Contribution (EFC) for financial aid purposes. Additionally, you won’t have a tax benefit for the money earned.
If you sell your crypto for capital gains, you might be able to benefit from the favorable long-term tax rate as long as you’ve held the crypto for more than a year. However, earnings from staking or yield farming are likely to be treated as interest and taxed as income. That's why it's important to keep up with your crypto bookkeeping by using various crypto and NFT tax software so you can track any gains.
When making these calculations, it’s important to consider that impact before you decide to use crypto as a way to save money for college.
Does Using Crypto To Pay For College Make Sense?
There are some schools, like the Wharton School at the University of Pennsylvania and The Kings College in New York City, that accept Bitcoin as payment. But if you hope to use crypto to pay for college elsewhere, you need to convert your crypto to fiat currency before you can pay the college tuition bill.
For some families, though, the idea of using crypto to save up for college is tempting. Even if they aren’t able to directly pay for college using cryptocurrency, the fact that they could see high returns for the investment and grow a portfolio to cover college costs can be attractive.
However, before you decide to stake your children’s future on cryptocurrency, it’s important to weigh the potential risks. Crypto represents a new asset class, so it’s very volatile. Price swings are a regular part of crypto investment. Additionally, there’s always the chance that crypto will crash just before you need to withdraw the coins to pay for college.
Another issue is whether the cryptocurrency will still be viable when your child goes to college. There are thousands of cryptocurrencies, and not all of them can have long-term staying power. Choosing the wrong crypto to base your child’s college future on can have disastrous results.
If you decide to use yield farming or staking, you might be able to withdraw your earnings regularly, such as weekly, and convert that to fiat currency, and then put that money in a more conventional 529 plan or another investment account. This can be one way to take advantage of some of the ways to quickly gain earnings with crypto, harvest those gains and then put them to work in a more conventional account where the assets aren’t as volatile.
When creating a college savings portfolio, putting a portion of the money into crypto can make sense, depending on your goals and your risk tolerance. You might be able to take advantage of growth with crypto by putting up to 10% of the portfolio in crypto while keeping the bulk of it in assets like stocks and bonds.
In short, determine how much of the college savings asset allocation makes sense in crypto and take steps to limit your exposure to risk.
The Bottom Line
Whether you decide to invest in crypto to save up for a child’s college depends on your risk tolerance and whether you think crypto is likely to become a long-term asset. You can use custodial accounts to take advantage of some tax benefits, depending on the situation, but you likely won’t be able to use a 529 to invest in crypto.
Carefully consider your situation, and whether you think crypto is a viable long-term asset class that can help you pay for college later. Create a strategy that works for you while helping your child meet their educational goals.
Miranda Marquit, MBA, has been covering personal finance, investing and business topics for more than 15 years, and covering crypto topics for more than 10 years. She has contributed to numerous outlets, including NPR, Marketwatch, U.S. News & World Report and HuffPost. She is an avid podcaster, co-hosting the podcast at Money Talks News. Miranda lives in Idaho, where she enjoys spending time with her son playing board games, travel and the outdoors.