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529 Savings Plan vs. Roth IRA: Which is the Best for College Savings?


A student at a desk is hidden behind a tall mound of books.

It’s an objective fact that education has become more expensive than it was before.

The Georgetown University Center on Education and the Workforce found that the average cost of tuition, room, board, fees, textbooks, and electronic gadgets for undergraduate degrees increased by 169% between 1980 and 2020.

In fact, the average parent now pays a whopping US $75,000 to admit their child to a public university for four years. And, if past trends are any indication, education expenses will skyrocket in the coming years.


Is the Roth IRA or the 529 Savings Plan the Better Choice?

If your child is currently in school and their future is your prime priority, start investing now. However, when it comes to investing money in higher education, parents often feel confused about the best option to save. Here’s where 529 Savings Plans and Roth IRAs come into the picture. Both the 529 Savings Plan and the Roth IRA are tax-efficient investment instruments. However, they do not both provide the same benefits. The following sections explain the best features of both savings instruments so that you can make the best choice without burning the midnight oil.


529 Savings Plan Vs. Roth IRA: A Primer

The 529 Savings Plan and Roth IRA are the two most popular investment instruments parents use to save money for their children’s higher education needs.

A 529 Savings Plan refers to a college savings plan sponsored by states, institutions, or colleges that provides multiple tax benefits. The 529 Savings Plan enables you to benefit from the $10,000 annual distributions for K-12 tuition under the 2017 Tax Cuts and Jobs Act rules. Although 529 Savings Plans are generally investment accounts, some states provide prepaid, feature-rich tuition plans.


A Roth IRA refers to an Individual Retirement Account or IRA that facilitates after-tax contributions. Investors can withdraw their investment from the IRA fund after retirement without worrying about tax payments. Although the Roth IRA has been specifically designed to let investors create a retirement corpus, investors often use this tax-efficient investment instrument to accumulate funds for their children’s higher education.

Now that you know the basic premise of a 529 Savings Plan and a Roth IRA, let’s understand the biggest differences between the two so that you can make an informed decision.


529 Savings Plan Vs. Roth IRA: A Comparative Estimate


The Idea

A 529 Savings Plan is a tax-efficient way to save for college or university education expenses. All withdrawals from the 529 plan are tax-free if you use the funds for qualified education expenses. According to the Internal Revenue Service (IRS), qualified education expenses refer to the amount you pay towards tuition fees and miscellaneous expenses for higher education.


However, if you choose a non-qualified account distribution, your earnings from a 529 Savings Plan will be considered ordinary income, and you may have to pay a penalty of 10%. But, if the beneficiary receives any educational assistance, such as the Lifetime Learning Tax Credit, the American Opportunity Tax Credit, veterans’ educational assistance, or a scholarship, the 10% penalty will be waived. Also, the tax penalty is waived if the beneficiary dies or faces permanent or total disability.

A ROTH Individual Retirement Account (IRA) offers tax-free capital growth and withdrawals to an investor owning their account for a minimum of five (5) years and whose age is over 59 and a half years old. You can withdraw your contributions from a Roth IRA anytime you want to without paying any penalties or taxes. However, if you withdraw the returns or interest before five years from the investment date and 59 and a half years, your income will be considered ordinary income, and you may have to pay a penalty of 10% of the interest amount. But, the 10% penalty might be waived if you used the distribution amount for higher education purposes. Moreover, the penalty will be waived if the beneficiary dies or faces a permanent or total disability.


Contributions

The 529 Savings Plan’s contributions have no income limit. You can contribute any amount up to the ceiling of $15,000 every year. The ceiling is $30,000 for joint contributions. You can also make a lump sum contribution of $75,000 for a single and $1.5 lakh (100,000) for a joint contribution to front-load five years’ gift tax exclusions. It is worth noting that the lifetime (aggregate) contribution limit typically ranges between $2.35 lakh and 5 lakh. Your friends and relatives can also send money to your 529 accounts.

When it comes to Roth IRAs, the contribution limit is $6,000 ($7,000 for investors aged 50 and above) or the investor’s earned income. Also, a Roth IRA does not have any lifetime (aggregate) contribution limit. Moreover, unlike the 529 Savings Plan, the Roth IRA does not allow third-party contributions. But an investor may accept gifts and use the money to contribute to the Roth IRA account.

Investment Options

The 529 Savings Plan does not provide many options in terms of investment since it has a limited variety of actively and passively managed funds. The 529 Plan places more emphasis on equity investments when the beneficiary is young and reduces equity exposure as the beneficiary approaches college or university.

A Roth IRA invests in a wide range of investment instruments, including stocks, mutual funds, bonds, ETFs, and the like. So, investors can choose the plan that best matches their investment goals.


Taxation

When it comes to Roth IRAs, account holders may take home penalties and tax-free returns for contributing to Roth IRAs provided the distribution is qualified as per IRS norms. However, if the distribution is non-qualified, the returns will attract income tax and a penalty of 10%. But, if the distribution is for qualified higher education expenses, disability, or the death of the beneficiary, the returns are tax-free.


So, Who is the Winner?


A close-up shot of American bills and Bitcoins.

Both the 529 Savings Plan and the Roth IRA provide multiple benefits. However, the Roth IRA maybe more flexible and could provide more investment choices. Also, the tax benefits of a Roth IRA may make it more lucrative.

Material discussed is meant for general/informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss.

Central Financial Group is a financial management institution with a rich legacy of 40 years. We simplify investments, insurance, and financial planning for individuals, business owners, and families across the USA. Visit us to explore the fascinating possibilities of growing your hard-earned money and fulfilling your financial ambitions conveniently.

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