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12.05.19

Section 529 versus Roth IRA Plans: Choosing a College Savings Tool
Christofer Georgiou

Many people assume that a Section 529 plan is the ideal college savings tool. After all, it is called a “college savings plan.” But other vehicles can help parents save for college expenses, such as the Roth IRA.

Which one should you choose? It depends on several factors, including how much you intend to contribute and how you will use the earnings.

Plan snapshots

A 529 plan allows participants to make substantial non-deductible contributions, up to $400,000 or more, depending on the plan. The funds grow tax-free and there is no tax on withdrawals, provided they are used for “qualified higher education expenses,” such as tuition, fees, books, computers and room and board. If you use the funds for other purposes, you will be subject to taxes and a 10% penalty on the earnings portion. Some 529 plans are also eligible for state tax breaks.

Roth IRA contributions are also non-deductible and grow tax-free. And, you can withdraw those contributions anytime, tax and penalty free, for any purpose. Qualified distributions of earnings — generally, after age 59-½ and more than five years after your first contribution — are also tax and penalty free.

Advantages and drawbacks

The main advantages of 529 plans are generous contribution limits (with the potential of funding five years at once), the ability to accept contributions from relatives or friends, along with potential state tax benefits. Roth IRAs, on the other hand, are subject to annual contribution limits of $6,000 ($7,000 if you are 50 or older). So, even if you and your spouse each set up Roth IRAs when your child is born, the most you will be able to contribute over 18 years is $216,000. Another drawback is that you cannot contribute to a Roth IRA if your income exceeds certain limits. (But, it may be possible to avoid this obstacle by using a “backdoor Roth IRA” strategy.)

Related Read: “The ‘Backdoor’ Roth IRA Strategy

Funds in a 529 plan that are not used for qualified education expenses will eventually trigger taxes and penalties when they are withdrawn. However, with a Roth IRA you can use contributions, as well as qualified distributions of earnings, for any purpose without triggering taxes or penalties. This includes items that would not be qualified expenses under a 529 plan, such as a car or off-campus housing expenses that exceed the college’s room and board allowance. Plus, if you do not need all of your Roth IRA funds for college expenses, you can leave them in the account indefinitely.

Consider goals

Keep in mind that if a Roth IRA is part of your retirement plan and you want a college savings tool in addition to maximizing your Roth IRA each year, a 529 plan could be the solution.

Before selecting a plan, consider your overall financial, retirement and estate planning goals. Your financial advisor can help.

For more information, contact Chris Georgiou at cgeorgiou@orba.com or 312.670.7444. Visit ORBA.com to learn more about our Wealth Management Services.

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