- 529 college savings plans and Roth IRAs can help families save for college.
- Both accounts allow penalty-free withdrawals for education expenses.
- A 529 plan allows higher contributions with no income eligibility limits.
- You can also use a Roth IRA for retirement savings if your child doesn’t attend college.
The average cost of college, including tuition and living expenses, exceeded $35,000 in 2021. With college costs rising, saving for college is more important than ever. But what’s the right account for you?
A 529 college savings plan and a Roth IRA for college are two popular options. Before you start saving for college, make sure you understand the differences between a 529 vs. Roth IRA and which is right for your circumstances.
What Is a 529 College Savings Plan?
A 529 college savings plan offers tax and savings advantages. Any U.S. resident over the age of 18 can open a 529 account. These college savings plans cover many educational expenses, including trade and vocational school. And friends and family can make gift contributions to the account.
Every state sponsors a 529 plan, and in some states, there are tax advantages to contributing. However, you’re not required to use your resident state’s 529 plan. You can open a plan in any state, although you may lose the tax advantages your state offers.
You can also open a 529 through a financial services firm. Any withdrawals made for qualified educational expenses come with no federal income tax. However, there is a penalty on withdrawals for non-qualifying expenses.
Pros of 529 Plans for College Savings
Here are some 529 plan advantages:
529 plans offer tax-free growth on your savings.
Some states offer tax deductions for contributions.
Qualified expenses include K-12 tuition, vocational school, and living expenses.
Cons of 529 Plans for College Savings
Here are some 529 plan disadvantages:
Withdrawals for non-education expenses come with a 10% penalty.
Your state may not offer tax advantages for contributions.
Some plans charge high account management fees.
Your plan may offer limited investment options.
What Is a Roth IRA for College?
People typically use Roth IRAs for retirement. However, you can also use a Roth IRA to fund your college education, and whatever you don’t use is left over for your retirement fund. Roth IRAs offer several benefits. For example, Roth IRAs have more investment options than many 529 plans. And like a 529 plan, a Roth IRA benefits from tax-free growth. There are also no penalties on withdrawals for educational expenses.
However, Roth IRAs have annual contribution limits of $6,000 per year or $7,000 for those over 50. And high-income households do not qualify for Roth IRAs. States also don’t offer tax benefits on Roth IRAs. Those with more funds to save for college or want gifting options should choose a 529 plan.
529 Plan vs. Roth IRA: Which Is Right for You?
Which college savings option makes more sense for you? When comparing a Roth IRA vs. a 529 plan, consider the following factors.
How Much Do You Want to Contribute?
A Roth IRA comes with a maximum annual contribution limit of $7,000. In contrast, 529 plans offer much higher limits. They also allow friends and family to make contributions, unlike Roth IRAs. So consider your financial situation and whether others might contribute to college expenses when choosing a 529 plan vs. Roth IRA.
Does Your State Have Tax Advantages?
Many states offer tax advantages for 529 contributions. This includes a tax credit in the amount of your contribution. In some states, you can even deduct your entire contribution from your state income taxes. If your state offers tax advantages, a 529 plan may be the best choice. Check which states offer 529 deductions.
How Much Do You Make?
Unlike 529 plans, Roth IRAs have income limits. If you earn above the limit, you cannot save for college in a Roth IRA. For 2022, Roth IRA eligibility begins to phase out at $129,000 for single households and $204,000 for married households, according to the Internal Revenue Service (IRS).
Who’s the Beneficiary?
If you know the beneficiary will have educational expenses, a 529 plan might be the best choice. However, if you’re saving for multiple beneficiaries or you’re not certain whether the beneficiary will go to college, a Roth IRA might be better. That’s because you can always keep the Roth IRA savings for retirement.
Frequently Asked Questions About 529 Plans and Roth IRAs
Which is better: a 529 plan or a Roth IRA?
Both a 529 plan and a Roth IRA allow tax-free growth on your contributions. The right option depends on your unique circumstances. A 529 plan offers many benefits for families with high savings budgets and beneficiaries who will attend college. On the other hand, a Roth IRA might be the right option if the beneficiary is uncertain about attending college because you can use the savings for retirement.
Should I open a Roth IRA or 529 plan for my child?
You can open a 529 plan or a Roth IRA to save for your child’s college expenses. Both plans offer several options. For example, you can open a Roth IRA in your name and take out penalty-free withdrawals for your child’s college. You can also open a custodial Roth IRA for your child if they have earned income. With a 529 account, you can list your child as the beneficiary. You can also change the beneficiary on a 529 account.
Is a 529 plan the same as a Roth IRA?
No, a 529 plan and a Roth IRA are two different savings vehicles. 529 plans were specifically designed for college savings, while Roth IRA plans are most often used for retirement savings. Both provide tax-free growth and no penalties for education-related withdrawals. However, there are tax and savings implications of opening a 529 vs. Roth IRA, so carefully consider your options before choosing a college savings account.
Is the 529 plan worth it?
Yes, a 529 plan is a good option to save for college. In many states, your contributions provide a tax deduction or credit for your state income taxes. And contributions in a 529 plan grow without income taxes. These plans help families save for educational expenses. You can accept gift contributions from friends and family. These plans also let you change the beneficiary or use the funds for vocational school, private K-12 tuition, and living expenses.