You don't have to jsut use the 529 money for tuition. It can be used for any school-related expenses ... room & board, supplies, incidentals, etc. Even with scholarships, kids will have plenty of other expenses.
Long... Sorry.
Maybe. Maybe not. The argument that I have is the tax advantage of the 529 is offset by other factors. Such as the ordinary income tax rate and 10% penalty for non qualified distributions(for those households in the $77-$165k range that is 22%+10%.) Compared to a capital gains tax of 15% plus a $4,000 deduction off ordinary income taxes even if you don't itemize.
Let's say you put $25k in a brokerage account when a child is born and never add or withdraw for 18 years. Assume 8% annual return and you have $99,900 in the account in 18 years. That's $74,900 of earnings that will be taxed at 15% or $11,235. But if you withdraw over 4 years and take the $4k deduction each year. That's $16k of deductions at 22% or $3520. That is a net tax of $7,715.
I also hate the limitations on the account. One fund family and one trade or rebalance per year is not good for creating options for active management. The trade situation means you will have to drop out of equities significantly further from withdrawal time than if you have unlimited trades.
I personally am a big fan of passive investing. This means I look for broad index funds at super low fees. This will be real challenging in a 529 environment due to the fund isolation and program fees. In Mississippi it looks like asset based fees are in the 70 basis point range and they are in the same range or higher in Texas where I live (.58-.98.) Which is quite a bit more than the 5 basis points I pay with Vanguard.
Going back to the previous example, we assumed an 8% earnings on the brokerage account. Whether it's through active management gains by being able to trade at anytime or access other funds, stocks, bonds, ETFs, etc... I think it's fair to say an investment advisor or sophisticated personal investor can get better returns with more options. For passive investors, it's easy to get the 65 basis point spread between the Mississippi 529 and Vanguard fund I love (VFIAX.)
Using this math, I feel it would be fair to assume the 529 version of my $25,000 would earn 7.35% instead of the full 8%. So in my 529 version after 18 years I have $89, 614 of tax free money. But that is less than my $99,900 less the net tax liability of $7,715 or $92,185 in my brokerage account. I live in a no state income tax state, so I have ignored the effects of state income taxes... So with those factored in let's call it a push.
This example explains the advantage of the brokerage account and taxes with a lump sum. In a situation where most people are making annual contributions, your original investment makes up a greater percentage of the total account value thus lowering the tax liability of the brokerage account even more since only gains are taxed.
This is just one scenario, but I think it's real easy to see that if you feel you can earn 50-100 basis points more annually in a brokerage account, you can effectively match or out perform a 529. I don't think it's a stretch to make this assumption for most people. Add on to that the ability to access the cash for any reason without penalty and I am not signing up for a 529.
Now the biggest advantage of the 529 is that the money is locked away from grubby hands. No boat purchases or lavish vacations are coming with those penalties. I also love it for grandparents. It keeps the money from that idiot son or daughter in law and gives it to the grandkids.