Saturday, December 21, 2019

Fewer Tax Benefits

Fewer Tax Benefits
A Roth IRA offers fewer tax benefits than a 529 plan IF the money is used for higher education.

529 plans allow for tax-free withdrawals of earnings, while Roth IRAs do not (at least, not until you’re age 59-1/2).
Some states offer income tax deductions for contributions to a 529 plan. Roth IRAs never get this benefit.
If the money you’re saving does end up being used for college expenses, a 529 plan will likely save you more money.Big Boss vote

Not Counted as Asset for Financial Aid

Not Counted as Asset for Financial Aid
Many people worry about contributing to a 529 plan because of the impact on financial aid. That worry is largely overblown, mostly because only about 5% of the money inside of a 529 plan is actually counted for financial aid purposes, and because having money is much better than needing it.

Still, a Roth IRA isn’t counted as an asset for financial aid purposes at all, and the last time I checked 0% is less than 5%. So in some situations, having your college savings in a Roth IRA may help you qualify for financial aid.

The biggest reason to choose a Roth IRA over a 529 plan is the flexibility you have to use the money for various purposes.

Flexibility


For example, it’s generally more important to save for retirement than to save for college, simply because there are many ways to pay for a college education but you have only yourself to rely on for retirement.

With a Roth IRA, you can save money now and decide later what you want to use it for. If your retirement is on track through other accounts, you can direct the money to your child’s education. If not, you can keep the money in the Roth IRA for retirement.

And even beyond that, Roth IRAs are extremely flexible accounts with many potential uses, so contributing to a Roth IRA can open up more opportunities than contributing to a 529 plan.

Special Withdrawal Rule for Higher Education

Special Withdrawal Rule for Higher Education
Roth IRA withdrawals are 100% tax-free once you reach age 59.5, but the earnings are typically taxed and penalized if they’re withdrawn before then. Which means that in most cases you’ll want to avoid early withdrawals.

But there are some special rules that allow you to get around those penalties, especially if you’re withdrawing the money for college expenses:

You can withdraw up to the amount you’ve contributed without taxes or penalties at any time and for any reason. For example, if you’ve contributed $50,000 to your Roth IRA and it’s grown to $75,000, you can withdraw up to $50,000 any time you want without consequence.
You can withdraw the earnings penalty-free (but not tax-free) if the money is used for college expenses for you, your spouse, your children, or your grandchildren.

Limited Investment Options

Limited Investment Options
Like 401(k)s, 529 plans all offer a relatively limited lineup of investments. Depending on the plan you’re considering, that could mean that you don’t have a lot of good options.

For example, some plans are filled with expensive investments. And while cost isn’t the only factor to consider, it is the single best predictor of future investment returns and high-cost investments will be a significant obstacle to success.

The good news is that you’re allowed to choose any 529 plan offered by any state. You aren’t limited to your state’s plan and there are plenty of states that offer a strong lineup of high-quality, low-cost investments. You can see some of my favorite 529 plans here, and you can compare 529 plan costs here.

Fewer Tax Benefits

Fewer Tax Benefits A Roth IRA offers fewer tax benefits than a 529 plan IF the money is used for higher education. 529 plans allow for t...