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A 529 college savings plan is one of the best tools for funding education, but using the money incorrectly can lead to unexpected taxes and penalties. Whether you’re paying for tuition, books, or other college-related expenses, it’s important to understand how withdrawals work. Making even a small mistake — like using the funds on ineligible expenses or exceeding spending limits — can reduce your savings. Here are key tips to help you avoid 529 withdrawal penalties and make the most of your education funds.

What Is a 529 Plan?

A 529 plan offers a tax-advantaged way to save for a child’s future college expenses. You can make contributions to the 529 account, which can then be invested in a variety of assets (such as stocks, bonds, or mutual funds), and any earnings grow tax-free. You can make withdrawals from a 529 federal income tax-free if the funds are used for qualified education expenses.

If you withdraw money from a 529 and spend it on nonqualified expenses, you’ll pay ordinary income tax on any earnings, plus a 10% penalty. There are some exceptions — such as no penalty if your student receives a scholarship and you withdraw up to that amount from the 529, though you’ll still need to pay tax on the earnings.

💡 Quick Tip: You’ll make no payments on some private student loans for six months after graduation.

What Are Qualified 529 Plan Distributions?

Education expenses that are considered qualified within a 529 plan include:

•   College tuition and fees

•   Room and board (not to exceed the allowance for room and board included in the school’s cost of attendance)

•   Books and supplies

•   Computers and internet

•   K-12 tuition and expenses (up to $10,000 in per year, increasing to $20,000 per year starting on January 1, 2026)

•   Student loan payments (up to $10,000 per beneficiary)

•   Apprenticeship programs registered with the U.S. Department of Labor

What Are Nonqualified 529 Plan Distributions?

Some expenses you’ll encounter when your child goes to college, however, are considered nonqualified distributions. Withdrawing funds from your 529 to cover these expenses can trigger taxes and penalties:

•   Transportation costs

•   Sports expenses or monthly gym dues

•   Electronics and smart phones

•   Health insurance costs

•   Off-campus room and board in excess of what the school housing would cost

•   Costs associated with extracurricular activities

•   Fratnerity/sorority dues

Are Distributions Taxable?

Qualified withdrawals are federal income tax-free (and in some states, state income tax-free) as long as your total withdrawals for the year don’t exceed your child’s higher education expenses.

If distributions are used to cover nonqualified expenses (such as travel to and from college or entertainment expenses), any part of the distribution that is made up of earnings on contributions will be taxed as ordinary income and could also incur a 10% federal penalty.

What Is a 529 Early Withdrawal Penalty?

A 529 withdrawal penalty is an additional 10% federal tax imposed on the earnings portion of a withdrawal from a 529 plan if the funds are used for nonqualified educational expenses. This penalty is levied on top of standard income tax, which is also applied to the earnings. The original contributions to the 529 are made with after-tax dollars and are not subject to the penalty or income tax upon withdrawal.

Keep in mind, however, that there’s no early 529 withdrawal penalty like with retirement accounts. Funds can be withdrawn at any time penalty-free, provided they are used for qualified education expenses. They can also remain in the account indefinitely if not immediately needed, continuing to grow tax-deferred.

Recommended: Benefits of Using a 529 College Savings Plan

Can I Make a Withdrawal From 529 Without Penalty?

Yes, you can make a withdrawal from a 529 without penalty so long as you use the funds for qualified education expenses. In addition, the 10% penalty may be waived in certain situations.

529 Withdrawal Penalty Exceptions

Here are some scenarios where the 10% penalty won’t apply (though taxes still will):

•  The beneficiary dies or becomes disabled.

•  The beneficiary attends a United States military academy

•  The qualified education expenses were only taxed because the student or parents claimed the American Opportunity Tax Credit (AOTC) or Lifetime Learning Credit (LLC).

•  The beneficiary received nontaxable educational assistance, including college scholarships, fellowship grants, veterans’ educational assistance, and employer-provided educational assistance.

What if My Child Doesn’t Go to College?

If you’ve been saving for a child’s college education and they decide not to go to college, there are some other ways you use your 529 funds that won’t trigger taxes and penalties. Here are some options to consider:

Change the Beneficiary

When you open a 529 plan, you designate a beneficiary, which is the person whose education you’re saving for. However, that name isn’t set in stone — you can change the beneficiary at any time.

If the child you’re investing for decides not to go to college (or gets a significant scholarship), you can change the beneficiary to a younger child, yourself, or even a future grandchild. Alternatively, you can also simply leave the account, let it grow, and change the beneficiary at a later date.

Trade School or Apprenticeships

If your child decides they want to attend a trade school or apprenticeship program rather than go to a traditional college, you can use 529 funds to cover those costs (without paying any taxes or penalties), provided the institution participates in federal student aid programs or is registered with the Department of Labor.

Repay Student Loans

As a result of the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, 529 plan holders can make penalty-free withdrawals to pay off student loan debt (both federal and private) for the designated beneficiary, up to a lifetime maximum of $10,000 per person. You can also change the beneficiary multiple times to help pay down student debt for more than one family member.

Roll the Funds to a Roth IRA

Thanks to SECURE 2.0, passed at the end of 2022, you can make tax- and penalty-free rollovers to a Roth IRA, giving your beneficiary’s retirement savings a substantial head start. However, there are some conditions and limitations to keep in mind:

•  The 529 must have been open for at least 15 years.

•  Contributions made within the last five years aren’t eligible.

•  There is a $35,000 lifetime limit per beneficiary.

•  Rollover amounts are subject to annual Roth IRA contribution limits.

•  The Roth IRA must be in the beneficiary’s name

Other College Financing Options

If you don’t have enough funds in your 529 to fully pay for a child’s college education, there are still many ways to cover the costs. Here are some to explore:

•  Maximize financial aid: The first step is for the student to complete the Free Application for Federal Student Aid (FAFSA®) every year they are in school. The FAFSA determines eligibility for grants, work-study programs, and federal loans. Many schools also use FAFSA data to award their own institutional aid.

•  Research scholarships: Many private organizations, nonprofits, and community groups offer college scholarships. They may be awarded based on merit (such as academic, athletic, or artistic abilities) or financial need. Have your child search local community groups and online databases for various scholarship opportunities.

•  Borrow wisely: Federal student loans are often the best option for borrowing, as they typically offer lower interest rates and more flexible repayment options than private loans. If additional funding is needed, private student loans are an option, but your student may need a cosigner to get approved or secure a better interest rate.

💡 Quick Tip: Parents and sponsors with strong credit and income may find more-competitive rates on no-fees-required private parent student loans than federal parent PLUS loans. Federal PLUS loans also come with an origination fee.

The Takeaway

A 529 plan can be an excellent way to save for college, offering tax advantages for qualified educational expenses. However, it’s important to understand what constitutes a qualified withdrawal to avoid penalties and taxes on the earnings. If your child’s plans change, options like changing the beneficiary, using funds for trade schools or apprenticeships, and repaying student loans can help you utilize your savings without incurring penalties. By being aware of the rules and exceptions, you can maximize the benefits of your 529 plan and use your educational savings effectively.

If you’ve exhausted all federal student aid options, no-fee private student loans from SoFi can help you pay for school. The online application process is easy, and you can see rates and terms in just minutes. Repayment plans are flexible, so you can find an option that works for your financial plan and budget.

FAQ

How do I withdraw from a 529 without paying a penalty?

You can withdraw from a 529 plan without paying a penalty by using the funds for qualified education expenses. These include tuition, fees, room and board (up to the school’s allowance), books, supplies, computers, internet, and K-12 tuition.

The 10% federal penalty may also be waived in specific situations, such as the death or disability of the beneficiary, attendance at a U.S. military academy, or if the beneficiary received nontaxable educational assistance, such as scholarships or fellowship grants, and you withdraw up to that amount. In these cases, however, you may still owe ordinary income tax on the earnings portion of the withdrawal.

What is the 529 loophole?

The “529 loophole” typically refers to the “grandparent loophole.” As a result of changes to the Free Application for Federal Student Aid (FAFSA®) in 2024–2025, studentsno longer need to report distributions from a grandparent-owned 529. As a result, grandparent support won’t impact a student’s eligibility for financial aid. Another popular 529 “loophole” (made possible by the SECURE 2.0 Act) allows unused 529 plan funds to be rolled over into a Roth IRA for the beneficiary, though restrictions and limitations apply.

What are the exceptions to the 529 withdrawal penalty?

The 10% federal penalty for nonqualified 529 withdrawals can be waived in several situations. These include the death or disability of the beneficiary and the beneficiary attending a U.S. military academy. Also, if the beneficiary received nontaxable educational assistance (such as scholarships, grants, or employer-provided educational assistance) and you withdraw up to that amount, the penalty will not apply. However, in these cases, ordinary income tax on the earnings portion of the withdrawal may still be owed.

Photo credit: iStock/FG Trade

SoFi Private Student Loans
Please borrow responsibly. SoFi Private Student loans are not a substitute for federal loans, grants, and work-study programs. We encourage you to evaluate all your federal student aid options before you consider any private loans, including ours. Read our FAQs.

Terms and conditions apply. SOFI RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE. SoFi Private Student loans are subject to program terms and restrictions, such as completion of a loan application and self-certification form, verification of application information, the student's at least half-time enrollment in a degree program at a SoFi-participating school, and, if applicable, a co-signer. In addition, borrowers must be U.S. citizens or other eligible status, be residing in the U.S., Puerto Rico, U.S. Virgin Islands, or American Samoa, and must meet SoFi’s underwriting requirements, including verification of sufficient income to support your ability to repay. Minimum loan amount is $1,000. See SoFi.com/eligibility for more information. Lowest rates reserved for the most creditworthy borrowers. SoFi reserves the right to modify eligibility criteria at any time. This information is subject to change. This information is current as of 4/22/2025 and is subject to change. SoFi Private Student loans are originated by SoFi Bank, N.A. Member FDIC. NMLS #696891 (www.nmlsconsumeraccess.org).

SoFi Bank, N.A. and its lending products are not endorsed by or directly affiliated with any college or university unless otherwise disclosed.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SOISL-Q425-032

When you’re married and are each other’s beneficiaries, it makes sense to create a single joint will, right? Not necessarily. Even if you plan to leave everything to your significant other upon death, creating this kind of legal document may lead to complications down the line.

Let’s take a closer look at the different kinds of wills married couples can create so you can decide what’s best for you.

What Is a Joint Will?

A joint will is a single shared legal document, signed by two or more people. It is relatively uncommon today, and many attorneys recommend against them. One of the motivations for a joint will is that, when one person dies, it’s nearly impossible for a surviving spouse to change the terms of the will. This can be problematic because circumstances change over time. What if the person mentioned to inherit property in the will has passed away?

That said, a joint will for a couple can seem desirable precisely because it’s not flexible. This can ensure that a child from a previous marriage, for example, inherits what is outlined in the will even if their parent dies before their new spouse does. But these sort of permanent clauses can be handled in a trust, a customized estate planning tool that can allow for complex, shifting situations.

How Do Joint Wills Work?

A joint will for a married couple is a single document, signed by two partners. When you’re both alive, changes can be made as long as you both agree. But once a partner dies, the will becomes binding.

For this reason, a joint will for a married couple can be binding, restrictive, and not necessarily optimal for the complexity of modern-day life.

Say that the will stipulates that the house the couple owns will be inherited by their three children upon the death of both spouses. But what if the surviving spouse has a financial emergency and wants to sell the house? Or simply wants to downsize to a smaller living space? Because of the will, they could be stuck in a difficult scenario.

Also consider that a joint will doesn’t always cover the what-ifs that can come up during life. From remarriage to family disputes to having more children, a joint will can lock assets in time, making it tough for the surviving spouse to move on.

How Do Mutual Wills Work?

Fortunately, there are options for those who worry about a joint will being too rigid. A more common option that offers flexibility is what’s known as a mutual will, or mirror will. In this case, two documents are created, one for each spouse. They may be identical, but because they are two documents, separately signed, the surviving spouse can then modify their own individual will when their partner passes away.

But what if you are concerned that you might die first and your surviving spouse could, say, omit a child or other loved one from their inheritance? (Yes, that may sound odd, but life contains many complicated family situations!) In this case, lawyers may recommend a trust as an option to ensure that your own personal wishes are carried out when it comes to your property. The trust can also make sure that your directives are followed when it comes to joint property mutually owned, like real estate.

Recommended: Important Estate Planning Documents to Know

Joint Will vs Individual Will: Pros and Cons

So, what are the pros and cons of joint wills versus individual (separate) wills? In general, the biggest con against a joint will may be the lack of flexibility. But for some people with relatively simple estates, this can seem like a positive.

Pros of a joint will:

•   Simplicity. It’s a one-and-done proposition!

•   Clarity. It ensures that both partners’ wishes, as written, will be respected, even after death.

Cons of a joint will:

•   Rigidity. If a partner gets remarried or has more children, it will be complicated if not impossible to change the original will.

Pros of an individual will:

•   Flexibility. Yes, this is a double-edged sword. These wills aren’t carved in stone, which can be a good or bad thing. But with individual wills, the wishes of the partner who dies first may not be fully honored. These concerns may be solved by the creation of a trust.

•   Simplicity. You can create one document and each sign it separately. Each individual is then free to amend their own will.

Cons of an individual will:

•   Flexibility. Yes, this is a double-edged sword. These wills aren’t “carved in stone” which can be a good or bad thing. Here’s the latter: With individual wills, the wishes of the partner who dies first may not be fully honored. These concerns may be solved by the creation of a trust.

•   Maintenance-intensive. A surviving partner may want to rewrite their will over time as their life circumstances change.

Do Husbands and Wives Need Individual Wills?

In most cases, yes, it’s beneficial if spouses have separate wills. The wills can be identical, but having two distinct documents that are individually signed can help protect against what-ifs in the future. Having individual wills can give the surviving spouse flexibility.

Let’s say that a joint will stipulates that a house owned jointly by a married couple will go to children upon the death of both spouses. That means if one spouse dies, the other spouse may not be able to sell the house that he or she lives in, even in the case of financial hardship. A joint will can lock a surviving spouse in time, despite evolving circumstances.

Instead, a couple may prefer individual wills. These can mirror each other, but the surviving spouse retains flexibility in case their needs or circumstances change after the spouse dies.

Worth noting: For some, the lack of flexibility of a joint will may be seen as positive. For example, some couples may want a joint will to ensure their children receive an inheritance, even if the surviving spouse remarries. However, some legal experts believe this goal can better be achieved through the creation of a trust.

As you think about making your will, it can be helpful to consider the pros and cons of a joint will. Getting an expert opinion can also be a smart move.

What Happens to a Joint Will When Someone Dies?

A joint will is essentially frozen in time when someone dies. The will becomes “irrevocable,” and property must be divided according to the terms of the will. If it says all assets are to be inherited by the surviving spouse, then the surviving spouse will inherit assets. But confusion may occur if and when both spouses pass away. A joint will then makes it hard, if not impossible, to reallocate property.

Let’s consider another scenario to see why a joint will can be problematic. Perhaps a joint will specifies that a certain sum of money is to go to a charity upon death. If the charity no longer exists after one spouse passes away, this may lead to complications and a legal headache.

In short: A joint will is similar to a time capsule. While its contents may make sense now, it can be helpful to consider what-ifs that may happen ten, 20, or 50 years in the future. This can lead some couples to decide that individual wills will work better.

Recommended: Life Insurance Guide

Can You Make a Joint Will Online?

It is possible to make a joint will online. But because not every state recognizes a joint will, it’s important to make sure you live in a state that does before you move forward.

The Takeaway

End-of-life planning is an important way to express your wishes and protect those closest to you. A will is one key component of that, but married couples have an important choice to make when deciding whether to have joint or individual wills. Even if you and your spouse are the ultimate joined-at-the-hip lovebirds, having separate wills may be a good idea. It can often provide more flexibility and family peace in the years ahead.

When you want to make things easier on your loved ones in the future, SoFi can help. We partnered with Trust & Will, the leading online estate planning platform, to give our members 20% off their trust, will, or guardianship. The forms are fast, secure, and easy to use.

Photo credit: iStock/fizkes

Coverage and pricing is subject to eligibility and underwriting criteria.
Ladder Insurance Services, LLC (CA license # OK22568; AR license # 3000140372) distributes term life insurance products issued by multiple insurers- for further details see ladderlife.com. All insurance products are governed by the terms set forth in the applicable insurance policy. Each insurer has financial responsibility for its own products.
Ladder, SoFi and SoFi Agency are separate, independent entities and are not responsible for the financial condition, business, or legal obligations of the other, SoFi Technologies, Inc. (SoFi) and SoFi Insurance Agency, LLC (SoFi Agency) do not issue, underwrite insurance or pay claims under LadderlifeTM policies. SoFi is compensated by Ladder for each issued term life policy.
Ladder offers coverage to people who are between the ages of 20 and 60 as of their nearest birthday. Your current age plus the term length cannot exceed 70 years.
All services from Ladder Insurance Services, LLC are their own. Once you reach Ladder, SoFi is not involved and has no control over the products or services involved. The Ladder service is limited to documents and does not provide legal advice. Individual circumstances are unique and using documents provided is not a substitute for obtaining legal advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SOPRO-Q425-015

The Free Application for Federal Student Aid or FAFSA® form is required for students who are interested in receiving federal financial aid. Dependent students must report parents’ information when they fill out the FAFSA form, but this can become complicated when a student has parents who are divorced.

The federal government treats divorced parents differently than parents who are married. Understanding the requirements for the financial information required by the FAFSA could help students improve their chances of receiving federal student aid and potentially lower the amount of student loans they need to obtain a degree.

Continue reading for more information on filling out the FAFSA if your parents are divorced or separated.

What Complicates FAFSA for Divorced Parents?

The FAFSA treats parents who are divorced differently than it treats parents who are married. If a student’s parents are married, information about both parents must be included on the FAFSA form. If a student’s parents are divorced or separated, the parent who provided more financial support during the last 12 months is considered “the contributor” and must provide their information. If both parents provided an equal amount of financial support, the parent with the greater income and assets is the contributor and must provide their information.

If the contributing parent has remarried by the time a student is filing the FAFSA, your stepparent is considered a parent if they have adopted you. If they haven’t adopted you, the form may still prompt your parent to provide your stepparent’s information depending on their tax filing status.

Recommended: Important FAFSA Deadlines for Students and Parents

FAFSA Tips for Students with Divorced Parents

Here are some important questions to ask yourself and tips for completing the FAFSA application with divorced parents:

Who to Count as Parents for FAFSA

According to the FAFSA, a “parent” means your legal (biological and/or adoptive) parent.

If your parents are divorced, the FAFSA requests information from the parent who provided more financial support during the previous 12 months. If both parents shared support equally, you’ll provide information for the parent who earns more.

If your parent is remarried, you may need to provide information on the stepparent, as well.

What Is a Custodial Parent?

In the past, FAFSA defined a custodial parent as the parent you spend the most time living with during the year. The parent responsible for filing the FAFSA is now determined based on whichever parent provides more financial support to the student.

What About Stepparents and Common-Law Spouses?

Generally, you’ll need to provide the financial information for a stepparent who is married to the custodial parent.

Should Alimony Be Included as Income?

Any alimony or child support received by the custodial parent should be reported on the FAFSA.

Parent’s Education Level

The FAFSA will ask you to include the education levels of your parents. You only need to include information about either your birth or adoptive parents. In this section, the FAFSA does not need information about your stepparent.

What If My Divorced Parents Still Live Together?

If your parents live together, but are divorced, the marital status should be “Unmarried and both legal parents living together.” You need to provide information about both of them on the FAFSA form.

If your parents live together, but are separated, the marital status should be “married or remarried.” Do not use “divorced or separated.” You should provide information about both of them on the FAFSA form.

Additional Sources to Finance Tuition

Many students seek alternative financial aid to finance college if they do not qualify for federal aid or if the amount of federal aid allocated will not cover the entire tuition cost.

About half of college tuition and living expenses are paid by the income and savings of a student’s family members, according to a Sallie Mae study, “How America Pays for College 2025.”

Federal Aid

There are many other sources that could help a student obtain funding for tuition, books, and living expenses. When filling out the FAFSA, students are applying for federal financial aid. This includes federal student loans, the federal work-study program, and some federal grants. However, many states and colleges use the information from the form to award their own grants, scholarships, and loans.

Federal aid is provided on a first-come first-served basis, so it can potentially be helpful to file your FAFSA early. Check out even more detailed information in SoFi’s FAFSA guide.

Federal student loans can be either subsidized or unsubsidized.

Subsidized federal loans are given to students based on financial need. The interest on these loans is subsidized by the federal government, which means students will not be responsible for repaying the interest that accrues while they are enrolled at least part time or during their grace period.

Unsubsidized loans are not awarded based on need and will begin accruing interest as soon as the loan is disbursed.

Recommended: Types of Federal Student Loans

Scholarships

If federal aid is not enough to cover the cost associated with attending college, there are other options available to help you pay for college. Two sources of funding are grants and scholarships. These are highly sought after by students because they do not have to be repaid. Many of them require students to apply annually.

SoFi’s Scholarship Search Tool can help you find scholarships based on your location, level of study, and more.

Part-Time Job

Some students may also consider getting a part-time job to help pay for tuition or living expenses. Consider looking both on and off campus, or even online.

Private Student Loans

When other financial aid isn’t enough, private student loans can fill the funding gap for expenses like tuition, housing, and books.

Private student loans are offered by private organizations, like banks or online lenders, and can be more expensive than federal student loans. They also don’t come with the same borrower protections as federal loans, like deferment or income-driven repayment. That’s why private student loans are generally considered an option after students have exhausted all other sources of financing.

The loan terms and interest rate will vary from lender to lender and will likely be determined by the borrower’s financial history and credit score. Those interested in borrowing a private loan should consider shopping around with various lenders to find the best fit for them.

The Takeaway

Navigating the FAFSA process can be complex, especially for students whose parents are divorced or separated. The key is to correctly identify the “contributor” parent based on who provided more financial support, and to understand how stepparents and living arrangements can impact the application. By understanding these nuances and exploring all available funding options — including federal aid, scholarships, grants, part-time jobs, and private student loans — students can maximize their chances of securing the financial assistance needed for their education.

If you’ve exhausted all federal student aid options, no-fee private student loans from SoFi can help you pay for school. The online application process is easy, and you can see rates and terms in just minutes. Repayment plans are flexible, so you can find an option that works for your financial plan and budget.

FAQ

Does FAFSA require both parents’ income if they are divorced?

If your parents are divorced, you’ll generally report the information for the parent who provided the most financial support for the past 12 months. If your parents split financial support equally, then the parent with the greater income is responsible for completing the FAFSA.

How do you determine who parent 1 and parent 2 are for FAFSA?

The FAFSA doesn’t currently specify a parent “1” or “2.” Instead, it directs you to provide information for the “parent” (if your parents are divorced, this would be the parent who provided more financial support in the past 12 months), then provide information for the “parent’s spouse or partner.”

What is the maximum parent income to qualify for FAFSA?

There are no income limits when it comes to filling out the FAFSA or qualifying for federal financial aid. Even if your parents are high earners, you could still qualify for certain types of aid, such as scholarships or federal student loans. The FAFSA application is free to fill out, so it’s almost always worth taking the time to do so.

SoFi Private Student Loans
Please borrow responsibly. SoFi Private Student loans are not a substitute for federal loans, grants, and work-study programs. We encourage you to evaluate all your federal student aid options before you consider any private loans, including ours. Read our FAQs.

Terms and conditions apply. SOFI RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE. SoFi Private Student loans are subject to program terms and restrictions, such as completion of a loan application and self-certification form, verification of application information, the student's at least half-time enrollment in a degree program at a SoFi-participating school, and, if applicable, a co-signer. In addition, borrowers must be U.S. citizens or other eligible status, be residing in the U.S., Puerto Rico, U.S. Virgin Islands, or American Samoa, and must meet SoFi’s underwriting requirements, including verification of sufficient income to support your ability to repay. Minimum loan amount is $1,000. See SoFi.com/eligibility for more information. Lowest rates reserved for the most creditworthy borrowers. SoFi reserves the right to modify eligibility criteria at any time. This information is subject to change. This information is current as of 4/22/2025 and is subject to change. SoFi Private Student loans are originated by SoFi Bank, N.A. Member FDIC. NMLS #696891 (www.nmlsconsumeraccess.org).

SoFi Bank, N.A. and its lending products are not endorsed by or directly affiliated with any college or university unless otherwise disclosed.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SOISL-Q425-003

Life insurance provides a safety net for beneficiaries after a loved one dies. Broad choices exist between term life and whole life policies. Here is more info.

NBBO — the National Best Bid and Offer — is a quote available marketwide that represents the tightest composite spread for a security, e.g., the highest bid price and the lowest ask price for that security trading on various exchanges.

The NBBO is a regulation put in place by the Securities and Exchange Commission (SEC) that requires brokers who are working on behalf of clients to execute a trade at the best available ask price, and the best available bid price.

Brokers must guarantee at least the NBBO to their clients at the time of a trade, per SEC rules.

How Does “Bid vs Ask” Work in the Stock Market

In order to understand NBBO, investors need to understand the bid-ask price of a security, such as a stock. This is also known as the spread (two of many terms investors and traders should know). If an investor is “bidding,” they’re looking to buy. If they’re “asking,” they’re looking to sell. It may be helpful to think of it in terms of an “asking price,” as seen in real estate.

The average investor or trader will typically see the bid or ask price when looking at prices for different securities. Most of the bid-ask action takes place behind the scenes, and it’s happening fast, landing on an average price. These are the prices represented by stock quotes.

That price is the value at which brokers or traders are required to guarantee to their customers when executing orders. NBBO requires brokers to act in the best interest of their clients.

Recommended: How to Invest in Stocks: A Beginner’s Guide

What Is NBBO?

The National Best Bid and Offer (NBBO) is effectively a consolidated quote of the highest available bid and the lowest available ask price of a security across all exchanges. NBBO was created by the SEC to help ensure that brokers offer customers the best publicly available bid and ask prices when investors buy stocks online or through a traditional brokerage.

NBBO Example

Let’s run through a quick example of how the NBBO might work in the real world.

Let’s suppose that a broker has a few clients that want to buy stock:

•   Buyer 1 puts in an order to the broker to buy shares of Company X at $10

•   Buyer 2 puts in an order to the broker to buy shares of Company X at $10.50

•   Buyer 3 puts in an order to the broker to buy shares of Company X at $11

Remember, these are “bids” — the price at which each client is willing to purchase a share of Company X.

On the other side of the equation, we have another broker with two clients that want to sell their shares of Company X, but only if the price reaches a certain level:

•   Client 1 wants to sell their shares of Company X if the price hits $12

•   Client 2 wants to sell their shares of Company X if the price hits $14

In this example, the NBBO for Company X is $11/$12. Why? Because these are the best bid vs. ask prices that were available to the brokers at the time. This is, on a very basic level, how calculating the NBBO for a given security might work.

Recommended: Stock Trading Basics

How NBBO and “Bid vs Ask” Prices Are Calculated

Because the NBBO is updated constantly through the day with offers for stocks from a number of exchanges and market players, things need to move fast.

Most of the heavy lifting in NBBO calculations is done by Securities Information Processors (SIPs). SIPs connect the markets, processing bid and ask prices and trades into a single data feed. They were created by the SEC as a part of the Regulation National Market System (NMS).

There are two SIPS in the U.S.: The Consolidated Tape Association (CTA) , which works with the New York Stock Exchange, and the Unlisted Trading Privileges (UTP) , which works with stocks listed on the Nasdaq exchange.

The SIPS crunch all of the numbers and data to keep prices (NBBO) updated throughout the day. They’re incredibly important for traders, investors, brokers, and anyone else working in or adjacent to the markets.

Is NBBO Pricing Up to Date?

The NBBO system may not reflect the most up-to-date pricing data. Bid, ask, and transaction data is changing every millisecond. For high-frequency traders that are making fast and furious moves on the market, these small price fluctuations can cost them.

To make up for this lag time, the SEC allows trading via intermarket sweep orders (ISO), letting an investor send orders to multiple exchanges in order to execute a trade, regardless of whether a price is the best nationwide.

The Takeaway

NBBO represents the crunching of the numbers between the bid-ask spread of a security, and it’s the price you’ll see listed on a financial news network or stock quote.

The NBBO adds some legal protection for investors, effectively forcing brokers to execute trades at the best possible price for their clients.

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FAQ

What does NBBO mean in trading?

The National Best Bid and Offer (NBBO) is a marketwide quote for the highest bid price and the lowest ask price available for a security, across exchanges. That means it’s a composite or consolidated quote that ensures investors are getting the best available price for a security.

What is Level 2?

Level 2 is a subscription-based service offered by Nasdaq that gives traders access to live trading data from the exchange, including bid-ask spreads and order sizes from market makers. Level 2 offers more in-depth information about pricing than NBBO, which is part of a Level 1 trading screen.

What is the advantage of NBBO?

First and foremost, NBBO helps protect investors, by ensuring the tightest spreads for securities prices. As such, NBBO also promotes market transparency and competition.

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