529 or Roth...Which is Better?
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529 Plans, aka Qualified Tuition Programs, are an excellent way to create college savings and an all around Good Thing®. Like Roth accounts, contributions to 529s grow tax-free, but unlike Roths, there’s no 5 year waiting period. And Roth accounts can be complicated. There’s Roth IRAs and Designated Roth Accounts and contribution limits and whatnot. On the other hand, money in a Roth can be used for any purpose, including beer and fishing tackle, while 529 plan college savings distributions must be used for education. So which is better for college savings? You guessed it...it depends. Here’s a look at some of the differences.
You might do better with a Roth if:
- You’ll be nearing or over 59½ when your child enters college and you file in a state that doesn’t offer a tax deduction on 529 college savings contributions (I’m looking at you, California, and you, Florida.) A Roth can give you the same tax benefits as a 529 but more flexibility.
- You’re not sure how much you need or want to contribute to a 529. Putting your money in a Roth lets you have your cake and eat it too. You can put off deciding how much to devote to education and still get tax-free growth. Once your Roth account is 5 years old, you can withdraw the money for education, or for anything else.
- With a Roth IRA, you can withdraw your money tax- and penalty-free for any reason as long as you’re at least 59½. It doesn’t matter how recently you put the money in as long as at least one of your IRAs is in kindergarten (at least 5 years old.) If you’re under 59½, you can withdraw contributions but not earnings. All that flexibility can be very nice if your plans or circumstances change.
- Designated Roth Accounts can have additional distribution rules that vary from plan to plan (so check your plan) but they also let you withdraw your money for any reason.
- You want to actively manage your investments. You can trade stocks, mutual funds and ETFs in a Roth, but you can’t in a 529 college savings account. You can only change investments in a 529 twice a year or when you change beneficiaries.
If you’re in the right age group, ask your tax advisor. A Roth might be the way to go.
But... Whoa, Nelly! Here are some reasons you might do better with a 529:
- You won’t be old enough -- you have to be 59½ -- to get all the benefits out of a Roth.
- You file in a high tax state that offers tax benefits for 529 college savings contributions.
- You want to force yourself to use the money for education and nothing else.
- You’re bumping up against Roth contribution limits.
It can be a close call. In the end, I used a 529 rather than a Roth for my kids. New York is a high tax state that offers a tax deduction for 529 contributions, and I was pretty sure we would use all the 529 money for education. YMMV.
How to decide? Check your state’s 529 Plan and run the numbers. See if it’s feasible to use a Roth. And when making decisions involving your taxes, always -- I mean always -- consult a tax professional.
Dan Ellentuck, known as College Fin Aid Dad, blogs on college financing and other personal finance topics. The experience of applying for financial aid for his two sons inspired this piece.