What is Roth vs. 529 – Which Is Better?
Roth IRAs and 529s are two types of tax-friendly accounts that can help families save for a college education. As with any other type of savings program, no one is perfect for all families, and both offer great benefits. Each has downsides. Understanding the basics of the game Roth vs. 529 can help you decide which one (maybe both) is best for you.
How does a Roth IRA work and its pros and cons
The Roth IRA was originally designed as a retirement plan, and can also be used to save for college.
With this plan, you can withdraw the principal portion that is tax-free and without penalties and use it for any purpose after reaching retirement age. An early withdrawal may attract income tax and penalties unless funds are withdrawn to pay eligible higher education expenses.
There are limits to income and contribution to this plan. Until 2021, spouses who earn less than $198,000 can contribute up to $6,000 to a Roth IRA. Spouses who earn $208,000 or more are not eligible for a Roth account.
Benefits of a Roth IRA
Contributions and income are not subject to tax.
Contribution or capital can be withdrawn at any time without any penalty or income tax.
When the account holder turns 59 years and 6 months old, all money — principal and interest — can be withdrawn without penalty or taxes to help with children’s education expenses.
Any money left in the account can stay in a Roth to fund the account holder’s retirement.
Disadvantages of a Roth IRA
Spouses who earn more than a certain income cannot contribute to a Roth IRA.
Income and annual contribution limits can limit your savings potential.
Using Roth’s college savings reduces your retirement money, which would have been tax-deductible if withdrawn after retirement age.
How College 529 Savings Plan Works and Its Advantages and Disadvantages
With a 529 account, there are no limits to age, income, or annual contribution. There is also no minimum contribution amount. You can later adjust your contribution according to your money at that time.
529 accounts are created by state and each state sets its own requirements and conditions. You do not necessarily have to open a 529 account at your place of residence. You can open an account in any state that offers better benefits.
There are two 529 plans. Savings plans, which are tax-advanced savings accounts and prepaid tuition plans, allow you to pay tuition fees up front at certain colleges.
If the funds are not used for the education of the specified beneficiary, another beneficiary may be selected from a specified list of family members.
Advantages of 529 plan
There are no age or income limits, but you must limit your annual contributions to $15,000 per beneficiary to avoid federal gift taxes.
Contributions and earnings are tax deductible provided they are used to cover eligible educational expenses. These include college tuition, fees, room and board, $10,000 in student loan repayment, and $10,000 annually in K12 tuition.
The beneficiary can be changed if the original beneficiary did not use the funds to pay for higher education.
The 529 plan can be started for as little as $25.
It’s pretty much a set-and-forget-it investment model where you just invest money and watch it grow. Low start-up funds and an easy investment model make it easy for anyone to get started.
Disadvantages of 529 plan
Limited investment options. Since each state offers different terms and benefits for their 529 plan, you need to check plans carefully to choose one that works well.
If the amount is not used for educational expenses as specified in the terms of the plan, you will pay the tax. Also, you pay a penalty of 10% for withdrawing funds.
Plans are limited to one beneficiary at a time. Families with more than one child must open more than 529 plans.
The 529 large assets can reduce financial aid for a college student.
Roth vs. 529: The main takeaway
A Roth IRA may be a better option to save in college if:
You want the flexibility to be able to use the money for your retirement.
There is some uncertainty about your child going to college and no other family member is planning to attend either. In this case, the money will automatically go to your retirement fund.
529 may be a better option to save in college if:
You want to contribute more than your Roth IRA allows each year.
You want the flexibility to be able to change beneficiaries if your child chooses not to attend college.
You will need a savings account that family members and friends can contribute to.
Your high income disqualifies you from contributing to a Roth IRA.
Roth’s plans for 529 aren’t your only options. Learn more about the different types of savings plans and consider using our financial planning tool today.