529 Plans vs. Roth IRA: Which is Better for College Savings?

When it comes to saving for your child's college education, you'll hear two recommendations more than any others: 529 plans and Roth IRAs.

Both are powerful savings vehicles with significant tax advantages. But which one is right for your family? The answer might surprise you—because in many cases, the best strategy involves using both.

Let me break down how each option works, their advantages and disadvantages, and how to decide which approach makes sense for your situation.

Understanding 529 College Savings Plans

A 529 plan is a tax-advantaged investment account specifically designed for education expenses.

How 529 Plans Work

You contribute after-tax dollars to the account, which then grows tax-free. When you withdraw the money for qualified education expenses, you pay no taxes on the growth.

**Qualified expenses include:** - Tuition and fees - Room and board (if enrolled at least half-time) - Books and required supplies - Computers and related equipment - Up to $10,000 per year for K-12 tuition - Up to $10,000 lifetime for student loan repayment

The Tax Benefits

**Federal Tax Benefits:** - Tax-free growth - Tax-free withdrawals for qualified expenses - No income limits on contributions - High contribution limits (typically $300,000+ per beneficiary)

**State Tax Benefits:** Most states offer a state income tax deduction or credit for 529 contributions. This varies by state, but it's often a deduction of $2,000-$10,000 per year.

In Texas, we don't have state income tax, so this particular benefit doesn't apply—but the federal benefits still make 529 plans attractive.

The Flexibility Features

**Change beneficiaries:** If your child doesn't go to college or doesn't use all the money, you can change the beneficiary to another family member (sibling, cousin, grandchild, even yourself).

**New rules for leftover funds:** Starting in 2024, you can roll over up to $35,000 of unused 529 funds to a Roth IRA for the beneficiary (subject to certain conditions). This is a game-changer that eliminates one of the biggest concerns about 529 plans.

The Drawbacks

**Limited to education expenses:** If you withdraw money for non-qualified expenses, you'll pay income tax on the earnings plus a 10% penalty.

**Investment options are limited:** You're restricted to the investment options offered by your specific 529 plan. Most plans offer age-based portfolios that automatically become more conservative as college approaches, plus various mutual fund options.

**Impact on financial aid:** 529 plans owned by parents are counted as parental assets on the FAFSA, reducing aid eligibility by up to 5.64% of the account value. This is actually better than most other savings vehicles, but it's still a factor to consider.

Understanding Roth IRA for College Savings

A Roth IRA is a retirement account, but it can double as a college savings vehicle with some strategic planning.

How Using a Roth IRA for College Works

You contribute after-tax dollars (just like a 529). The money grows tax-free. Here's the key: you can always withdraw your contributions tax-free and penalty-free for any reason, including college expenses.

After age 59½, you can also withdraw earnings tax-free. Before that, you'd normally pay taxes and a 10% penalty on earnings withdrawals. However, there's an exception: you can withdraw earnings penalty-free (but not tax-free) for qualified education expenses.

The Contribution Limits

**For 2024:** - $7,000 per person under age 50 - $8,000 per person age 50 and over - Income limits apply (phase-out begins at $146,000 for single filers, $230,000 for married filing jointly)

This is significantly less than what you can contribute to a 529 plan, which is a major limitation.

The Flexibility Advantage

This is where Roth IRAs shine: the money isn't locked into education expenses.

**You can use it for:** - College expenses - Retirement (the original purpose) - Emergency fund if needed - First-time home purchase (up to $10,000) - Any other purpose (at least your contributions)

If your child gets a full scholarship, wins the lottery, or decides not to go to college, your Roth IRA is still serving its primary purpose: funding your retirement.

The Financial Aid Benefit

Retirement accounts aren't counted as assets on the FAFSA. This means a Roth IRA has zero impact on your child's financial aid eligibility (at least until you actually withdraw the money).

However, when you do take distributions to pay for college, those withdrawals count as income on the next year's FAFSA, which can reduce aid eligibility going forward.

The Drawbacks

**Lower contribution limits:** At $7,000 per year, it takes much longer to accumulate substantial college savings compared to a 529.

**Income restrictions:** High earners may not be eligible to contribute to a Roth IRA at all.

**Retirement security:** Every dollar you use for college is a dollar you can't get back for retirement. You can borrow for college, but you can't borrow for retirement.

**Earnings withdrawals are taxable:** While you can access Roth IRA earnings penalty-free for education, you'll still pay income tax on them (unlike 529 withdrawals, which are completely tax-free).

The Head-to-Head Comparison

Let's put them side by side:

Tax Benefits **529 Plan:** Tax-free growth and withdrawals for education. Possible state tax deduction. **Roth IRA:** Tax-free growth. Contributions withdraw tax-free. Earnings taxable (but penalty-free) for education. **Winner:** 529 (slightly), due to fully tax-free withdrawals for education

Contribution Limits **529 Plan:** Very high ($300,000+ per beneficiary) **Roth IRA:** Low ($7,000 per year, subject to income limits) **Winner:** 529 (by a mile)

Flexibility **529 Plan:** Limited to education or penalties apply (though you can change beneficiaries) **Roth IRA:** Use for anything without penalty (contributions); primary purpose is retirement **Winner:** Roth IRA

Financial Aid Impact **529 Plan:** Counted as parental asset (5.64% impact) **Roth IRA:** Not counted as asset (but distributions count as income) **Winner:** Roth IRA (marginally)

Investment Options **529 Plan:** Limited to plan offerings **Roth IRA:** Invest in anything (stocks, bonds, mutual funds, ETFs, etc.) **Winner:** Roth IRA

So Which Should You Choose?

Here's my recommendation for most families:

Strategy 1: Max Out Roth IRAs First (For Lower Savers)

If you're saving less than $14,000 per year for college (or $7,000 if single), consider maxing out Roth IRAs before opening a 529.

**Why this works:** - You get all the benefits of saving for college - You maintain flexibility for retirement - Better financial aid treatment - If college becomes free or your child gets scholarships, you haven't over-saved in an education-specific account

**Example:** Married couple contributes $14,000 per year to their Roth IRAs. Over 18 years with 7% returns, that's approximately $540,000. Even if they only use their contributions ($252,000) for college, that's substantial education funding while building retirement savings.

Strategy 2: Roth IRA + 529 Combination (For Higher Savers)

If you're saving more than $14,000 per year, max out your Roth IRAs, then direct additional savings to a 529 plan.

**Why this works:** - You're building retirement security first - You get the full tax benefits of 529 for larger college savings goals - You maintain some flexibility (the Roth portion) - You can save enough to actually cover college costs

**Example:** Married couple contributes $14,000 to Roth IRAs plus $10,000 to a 529 plan annually. Total annual savings: $24,000. The Roth provides flexibility and retirement security; the 529 provides dedicated, tax-free education funding.

Strategy 3: Prioritize 529 if You Have State Tax Benefits

If you live in a state with generous state tax deductions for 529 contributions, and you're confident your children will attend college, prioritizing the 529 makes sense.

**States with the best 529 tax benefits include:** - Colorado (full deduction) - New Mexico (full deduction) - South Carolina (full deduction) - West Virginia (full deduction)

Even in these states, I'd still recommend maxing Roth IRAs if possible before going all-in on 529s.

Strategy 4: 529 Only (For High-Income Families)

If your income is too high to contribute to a Roth IRA, your decision is simpler: use a 529 plan for college savings.

You might also consider: - Backdoor Roth IRA conversions (consult a tax professional) - Taxable brokerage accounts for additional flexibility - Custodial accounts (UTMA/UGMA) though these have less favorable tax treatment

Common Questions

**Q: Can I contribute to both a 529 and Roth IRA in the same year?** A: Absolutely. Many families do both.

**Q: What if my child doesn't go to college?** A: With a 529, you can change the beneficiary to another family member or (as of 2024) roll up to $35,000 to a Roth IRA for the beneficiary. With a Roth IRA, it remains your retirement account.

**Q: Should grandparents use 529s or Roth IRAs?** A: Grandparents should generally use 529 plans. They can't contribute to a Roth IRA for grandchildren (the child needs earned income), and 529s offer estate planning benefits. Plus, grandparent-owned 529s no longer hurt financial aid eligibility under the new FAFSA rules.

**Q: What about Coverdell ESAs?** A: Coverdell Education Savings Accounts have lower contribution limits ($2,000/year) and more restrictions than 529s. For most families, 529s or Roth IRAs are better options.

**Q: How much should I save for college?** A: This depends on whether you plan to fund 100% of college or a portion. For a public in-state university (4 years), budget $100,000-$150,000 per child. For private universities, plan for $200,000-$300,000+ per child. Many families aim to cover 50-75% and plan on scholarships, financial aid, or student loans for the rest.

Action Steps

**1. Evaluate your annual college savings capacity** How much can you realistically save each year?

**2. Check your Roth IRA eligibility** Are you within the income limits? If so, how much can you contribute?

**3. Research your state's 529 plan** Does it offer state tax benefits? What are the investment options and fees?

**4. Decide on your strategy** - Under $14,000/year: Prioritize Roth IRAs - Over $14,000/year: Max Roth IRAs, then add 529 - High income: Focus on 529 plans

**5. Open accounts and automate contributions** Set up automatic monthly transfers so saving becomes effortless.

**6. Review annually** Adjust your strategy as your income, goals, and tax laws change.

The Bottom Line

There's no universally "better" option between 529 plans and Roth IRAs. The right choice depends on your income, savings capacity, state tax situation, and comfort level with committing money to education expenses.

For most families, a combination approach offers the best of both worlds: flexibility through Roth IRAs and dedicated, tax-free college savings through 529 plans.

The most important thing? Start saving now. Whether you choose a 529, a Roth IRA, or both, consistent contributions over time will give your children options—and isn't that what we all want?

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Michelle Schee is a CERTIFIED FINANCIAL PLANNER™ professional serving families in Texas. This article is for informational purposes only and should not be considered personalized financial advice.