529 Plan vs. Roth IRA

Higher education is pricier than ever, and tuition hikes don’t show any sign of slowing down. But 529 college savings plans and Roth IRAs both include benefits to help you save for your children’s education. Investors use 529 plans specifically to pay for college. By contrast, Roth IRAs provide the chance to save for both retirement and college in a single account. Choosing which one to utilize is a complicated decision that can have long-term financial ramifications, so feel free to consult a financial advisor if you have further questions.

What Is a 529 Plan?

If you’re looking to save for your child’s future education, a 529 college savings plan is one of the most popular choices available. Each state, except Wyoming, offers its own 529 plan or multiple plans, as does Washington, D.C. But you can select any 529 plan in the country, no matter which state you live in.

529s include the ability to avoid federal income taxes and the majority of state income taxes on any qualified withdrawals. However, the only way to maintain this perk is to use the funds for qualified higher-education expenses or tuition for elementary and secondary schools. Should you spend the money elsewhere, though, you’ll have to pay all federal and state taxes in addition to a 10% federal tax surcharge.

There are two main forms of 529 plans: education savings plans and prepaid tuition plans. College savings plans allow account holders to save for the qualified education expenses and fees of their beneficiary through an investment portfolio. On the other hand, prepaid tuition plans are much more focused. Those who select these plans will pre-purchase credits at a university far ahead of time.

529 plans also come with many restrictions. Education savings plans are paired with specifically chosen investments, giving 529 plan account holders much less overall flexibility. Until your beneficiary attends school, a 529 plan will essentially lock your money in place. Furthermore, you must use the funds of a prepaid tuition plan at a participating school, or you run the risk of receiving a much smaller return on your account.

Government-based financial aid is one of the premier sources of funding for many college students. Just keep in mind that if you or your beneficiary has a 529 plan of any kind, they may be eligible for less in financial aid. This is because the government assumes that the money you’ve saved will cover a portion of the tuition and related costs. How much having a 529 plan impacts a person’s financial aid eligibility can vary and may be minimal.

What Is a Roth IRA?

A Roth IRA is a common retirement savings vehicle that account holders must fund with after-tax money. This means that if you choose a Roth IRA, you won’t be able to deduct your contributions on your annual tax return. All earnings and withdrawals are tax-free after you reach 59.5 years old.

But Roth IRAs also are a versatile tool when it comes to paying tuition and other education costs: You can pull from your funds before 59.5 without incurring a penalty if you are using the money on qualified higher-education expenses. This is an especially pertinent benefit for Roth IRA account holders who are 59.5 or older by the time they need to pay for their children’s or grandchildren’s tuition, room and board and other fees.

Once you reach 59.5 years old, you can withdraw the entirety of your Roth IRA’s balance (earnings and all) tax-free, assuming you’ve had the account for at least five years. Of course, Roth IRAs are tailor-made for individuals who believe their future tax rates will be higher than where they currently are.

529 Plan vs. Roth IRA: The Comparison

When it comes to taxes, 529 plans and Roth IRAs work in a fairly similar fashion. Each provides the chance to grow balances on a tax-free basis, though some states offer an additional 529 deduction. Anyone can get a 529 plan, regardless of income. Roth IRAs, by contrast, are not open to all. They have individual and joint maximum income stipulations, which for 2024 are $161,000 and $240,000, respectively. In turn, 529 plans have a few tax and eligibility advantages over Roth IRAs.

One area where 529 plans simply cannot match Roth IRAs is versatility. You can use Roth IRA accounts to fund both your retirement and a beneficiary’s education. You may find this especially attractive if you anticipate these educational costs to arise once you’re 59.5 or older. As soon as you reach this crucial age, you can withdraw the entirety or your account’s balance without tax implications. And for younger parents, too, Roth IRA withdrawals are penalty-free if you use the money on qualifying education expenses.

Ultimately, 529 plans exist for the sole purpose of helping families save for the expensive cost of education. The fact that consumers can take advantage of plans in any state affords them ample choice and therefore the chance to receive maximum benefits. But if you want to combine your retirement and education cost savings into a single account, a Roth IRA may be a better option.

How to Open a 529 Plan and a Roth IRA

State governments are typically very flexible in the rules surrounding eligibility for their 529 plans. You can open a plan in any state, regardless of where you call home. Once you choose the 529 plan for you, stop by the state’s website to learn how to start the process.

Roth IRAs call for a bit more groundwork than 529 plans, especially at the beginning. Many different financial institutions such as banks, brokerage firms and robo-advisors provide Roth IRAs. Banks will usually offer fixed interest rates that are, like certificates of deposit (CDs), tiered based on your account balance. For those who prefer a more DIY approach, online broker accounts will let you build your own investment portfolio. Lastly, a robo-advisor Roth IRA will select your investments for you based on your personal risk tolerance and other factors.

Bottom Line

529 plans and Roth IRAs are two tax-advantaged ways to save for future needs. While 529 plans are typically reserved for paying for qualified education expenses, Roth IRAs offer a bit more versatility and can be used for both retirement and education expenses. However, both options use after-tax money, allowing the funds to grow tax-free, which is a primary incentive of both.

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