Back-to-School Season is the Perfect Time to Save for College: 529 Plans vs. Roth IRAs

Back-to-school season can be a great time to consider how you plan to help your children or grandchildren fund their higher education. 529 plans are a popular savings vehicle and have continued to gain popularity since the Tax Cuts and Jobs Act changed the law to allow distributions to be used to cover the cost of attendance at a public, private, or religious K-12 school in addition to higher education.

A Roth IRA also can be a viable option to help fund college expenses. While a 529 plan does come with special tax breaks, a Roth IRA can provide more flexibility, allowing you to earmark as much or as little as you want for higher education expenses. Hilltop’s CEO Erik Brenner suggests using both to fund college if you can afford it.

529 Plan vs. Roth IRA conversation with Sunny 101.5's Traci Capellman:

TRACI: Whether a student attends a four-year institution, community college, or trade school — across the board — tuition has gotten more expensive. So, how can families save and help young people limit their debt?

Many don’t know there are two tax-smart ways to set aside money for higher education — 529 Plans and Roth IRAs. While 529 Plans are designed to pay for education, families can also tap into a Roth IRA for college. And some families use both to cover higher-ed expenses.

TRACI: I’ve heard of the Roth IRA as a retirement vehicle, but it’s news to me that Roth IRAs are used as a way to save for college.

ERIK: While its primary purpose is saving for retirement, a Roth IRA may also fund a child’s or grandchild’s college education. Under IRS rules, you need to earn income before contributing to a Roth IRA, so young grandchildren can’t have their own accounts.

But you can fund a Roth IRA if you have income below $122,000 and are single or below $193,000 if you’re married. And you can name anyone as the beneficiary.

You can also withdraw your principal contributions tax-free at any time — as well as avoid the 10 percent early-withdrawal penalty for investment gains by taking an early distribution to pay for qualified, higher-ed expenses.

TRACI: So, is it better to use a Roth IRA or a 529 Plan, to help pay for college?

ERIK: It really depends on what the funds are to be used for. Despite being designed for different purposes, both 529 Plans and Roth IRAs offer the same critical benefit — allowing contributions to grow tax-free.

On the face of it, 529s are a great way to amass substantial savings in a short period of time. Yet with a Roth IRA, any money you don’t end up spending on college can remain in the Roth to fund your own retirement. One isn’t necessarily better, they’re just different.

TRACI: Since no one can predict a child’s future, what happens if they don’t need the money for education? For example, if a child wins a scholarship or decides not to go to college.

ERIK: Well, this uncertainty tips the scales in favor of Roth IRAs. If a child or grandchild does not need or want to use the funds for education, the money can continue to grow in the account.

But I often tell eligible clients, who can afford it, “Why not fund both and enjoy the best of both worlds?”

TRACI: Thank you, Erik.

Which higher-education savings plan is right for you? As with many things, you’ll need to consult an expert — or two — if you want to understand what’s best for your specific set of circumstances.

Take the first step to make sure your children or grandchildren aren’t burdened by excessive student loan debt and sign up for a free 30-minute consultation.

Hilltop Wealth Solutions provides objective advice and comprehensive guidance across all aspects of people’s financial lives. Get started today!

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Hilltop Wealth Solutions is a registered investment adviser. This is not intended to be relied upon as investment advice, nor an offer to solicit to buy or sell any securities.

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