529 Plan vs. Roth IRA: The Best College Savings Plan

529 Plan vs. Roth IRA

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As the cost of living increases, so does the cost of putting your kids through college. According to the College Board, the cost of college tuition and fees alone for 2017-2018 averaged  $3,750 – $25,650 for public schools and $34,740 for private schools. Imagine how high that figure will go when you include the cost of housing, books, food and other expenses.

Not to make things worse but imagine the cost of that in a few years, in case your kid is still a toddler. However, there are ways to avoid a financial crisis when your kids head up to college- SAVING! In case you had not thought of it, it is not too late. In case you were already way up ahead, congratulations, but that is not all.

Now that you have decided to save for your kid’s education, you might be wondering how to go about it. There are a number of ways, actually, that can help you save for your kid’s education. Among these ways, are two very efficient ways, and yet, very confusing. Welcome, ladies and gentlemen, to the debate that is 529 Plan vs Roth IRA.

One of the best ways to know which of the two suits your needs is weighing the pros and cons. By the end of this article, you will know which side suits you on the 529 Plan vs Roth IRA debate.

First things first

Definitions:

A 529 Plan is a savings plan that is designed specifically for future education purposes. Whatever you save for retirement and other saving plans is kept separate from this plan. Most importantly, any funds that go into this savings plan must be used for future education costs only.

Roth IRA, on the other hand, is retirement savings account that you can use to save your post-taxed income. Any future withdrawals made from this account are not taxed. With Roth IRA, you can use these funds for many purposes, education costs being one of them.

529 Plan vs Roth IRA: The Pros and Cons

529 Plan Pros

With the 529 Plan, you might qualify for the state tax savings. Most of the states offer the 529 Plan, but they can also vary from one state to the other. Over 30 states with the 529 Plan offer tax credits or deductions to individuals that contribute.

Before signing up, you can weigh between a number for them to see which one suits you better because it is not a must that you contribute to your state’s 529 Plan. However, it is important to note on most occasions, you have to contribute through your states plan if you want to enjoy the tax credits and deductions.

The 529 Plan is also flexible when it comes to scholarships and beneficiaries. What this means is that in case your child gets a scholarship or they decide not to attend college, you can change the beneficiary details. This will allow you to use those funds for your next kid’s college expenses.

You are also allowed to withdraw funds from the account in case your child gets a scholarship. As good as that sounds, you can only withdraw up to the amount of the scholarship, no penalties, but you have to pay tax for the income.

Thirdly, the high contribution limit of the 529 Plan allows an individual to save up to $14,000 in a year. Better still, for married couples, this amount goes up to $28,000. Whichever scenario you are in, contributions to these limits do not attract any gift tax.

529 Cons

While the tax credits and high contributions sweeten the deal, consider the below before signing up on a 529 Plan:

For starters, the 529 Plan does not leave you with much when it comes to investments.529 Plans attract penalties in case you move your funds to an investment plan that attracts more in terms of interest payments such as mutual funds.

The money, too, must be used for college tuition only failure to which it attracts a 10% penalty. If the money is used for other purposes, the federal and the state governments tax it as incomes using your tax bracket. To avoid such especially when your kid is done with college and there are still some funds in the account, you can estimate the tuition fee and use this to save.

The 529 Plan could also affect your eligibility for financial aid. Since the 529 Plan is treated as a parental asset when it comes to financial aids, the Department of Education can factor in up to 5.64% of the 529 Plan as a contribution towards your kid’s college tuition. This, in return, could affect their eligibility for any financial aid such as subsidized federal student loans and grants.

Roth IRA Pros

Roth IRA gives you an array of investment options, which will mostly depend on your state. From mutual funds to bonds and stocks among others, the choice is really yours.

It is also flexible in that it allows you to use the funds for other things such as retirement. Say, for example, you were saving for your kid’s education and the get a scholarship, you can use the money saved for your retirement. Additionally, you can withdrawal up to your principal contribution without paying any penalty, unlike the 529 Plan.

In case your kid wants to apply for any financial aid such as subsidized federal student loans and grants, they will be eligible because Roth IRA is not part of your assets. In simple terms, ROTH IRA does not affect your kid’s future financial aid eligibility!

Roth IRA Cons

Well, before you start celebrating, Roth IRA has a contribution limit. You can only contribute between $5,500 and $6,500 per year. However, in case you are 50 years and above, there is a catch-up contribution of $1,000 per year. For those planning to send their kid’s to expensive schools, you might need to rethink that.

The income limit of Roth IRA’s might also hinder some individuals from contributing. What this means is that in case you do not meet their income requirements, whether married or not, then you cannot contribute to the Roth IRA plan.

Roth IRA is usually very ideal for retirement plans. However, in case you decide it is a good savings plan for your kid’s college tuition, then a conflict of interest might arise given the limit in contributions. Using these funds for education might affect your retirement plans- financially.

For those struggling to save too, Roth IRA comes with another hard to swallow the pill, which is payment of taxes upfront.

529 Plan vs Roth IRA: Verdict

When all is said and done, the decision between the two will vary from one person to the other. The one I choose does not necessarily have to be the one that suits you. Look at your financial position at the moment, and where you want to be in the future. These might help you in making the right decision. If, for example, you are behind with your retirement contributions, Roth IRA might be the right choice for you at the moment.  For parents that think student loans and financial aids will help their kids through college then Roth IRA is the ideal plan. If, however, you feel you need to save specifically for your kid’s college tuition, the 529 plan is the ideal saving plan.

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