College Savings Plans
College is expensive. That might be the biggest understatement we could make. According to the College Board, the average tuition and fees for a private school were $34,740, for in state public schools $9,970, and for out of state public schools $25,620. Any way you slice it that is a lot of money! That makes it even more important that if you have young children, you begin planning for their future now.
There are many different ways to save for your child’s college education. The top two ways that we recommend are the 529 plan and the Roth IRA. Both have their own benefits and disadvantages and to see a more comprehensive look at those check out this article. Here we want to simply give you a basic overview of these two options and why they make sense to consider as you begin the process of building a college fund for your child or grandchild.
The 529 Plan
So what is a 529 plan? It is a college savings account that offers tax advantages when used for college expenses. There are two types of these plans, prepaid tuition plans and savings plans. Prepaid tuition plans have some pretty serious limitations and so we won’t go into great detail about them here.
Savings plans allow greater flexibility. Here are a few of the advantages to a 529 Savings Plan:
- No deduction for contributions
- Money grows tax-free while inside the account
- Money can be withdrawn tax-free for qualified higher education expenses
- Some states offer an income tax deduction for contributing to your home state’s 529 plan
- Eligibility is not impacted by income
- Total contribution limits are usually between $200,000 and $400,000
- Beneficiaries can be changed easily to any member of the original beneficiary’s family
- If your child earns a scholarship, you are able to withdraw up to the amount of that scholarship penalty-free
There are a few disadvantages that go with a 529 Plan as well.
- There are penalties and taxes if the money is withdrawn for a reason other than paying for college
- There are limited investment options
- A 529 is limited to higher education, meaning it cannot be used to cover private school tuition or tutoring prior to college
The Roth IRA
If you have spent any time reading about investing, you have undoubtedly heard of the Roth IRA. While a Roth IRA is technically a retirement account, it can also be used as an alternative college savings account as well.
Here are some of the benefits of using a Roth IRA as a college savings plan:
- You can withdraw the full amount of your contribution at any time without taxes or penalties
- If you are using the funds for college expenses for yourself, your spouse, your child, or your grandchild, you can withdraw from your account penalty-free (but not tax-free)
- Your money grows tax-free inside a Roth IRA
- A Roth IRA is more flexible than a 529 because you can use it for things other than college expenses
- Roth IRAs are not counted as an asset when applying for financial aid
- Wider range of investment options than a 529 Plan
There are a few disadvantages to using a Roth IRA instead of a 529 Plan:
- While 529 Plans allow for tax-free withdrawals of earnings, Roth IRAs do not until you are 59.5
- Roth IRAs do not offer the state income tax deductions that some 529 Plans have
- Using a Roth IRA for college sacrifices valuable retirement savings space
- Roth IRAs have substantial contribution limits $5,500/year or $6,500/year if you are over 50
- There are additionally income limits that may prevent you from contributing at all
Conclusion
There are obviously reasons why you might choose either option in order to meet your college savings needs. First, if you are not sure that you will need to use the money for college, a Roth IRA is probably the way to go. It is more flexible and sets you up for retirement if you end up not needing the money for college. If you are certain that the money is going to be used for college and your retirement accounts are well in hand, a 529 is what makes the most sense.
Ultimately what is important is that you are intentional about saving for your children’s college. If you are, whether you choose a Roth IRA or a 529 Plan, you will be much better off than the many who have no college savings of any kind.