Roth IRA Vs. 529 Plans (2024)

When planning for college, parents take on the bulk of the responsibility. According to the College Savings Foundation, 83% of parents save money for their children’s college education.

However, just 29% said 529 plans were their primary savings vehicle. Another popular but nontraditional option is to tuck money away into a Roth IRA.

Roth IRA vs. 529 Plan

What Is a Roth IRA and How Can You Use it for College Fees?

A Roth IRA isn’t a college savings plan; instead, it’s an Individual Retirement Account (IRA), intended to help you save and invest for your future in retirement. Roth IRAs are unique in that you contribute after-tax dollars. Your money can grow tax-free and, when you reach retirement age, your distributions from the account are tax-free, too.

Some people opt to use Roth IRAs as savings vehicles for their child’s college education rather than a 529. While there are some benefits to that strategy, there are some significant downsides, too.

Pros of Using a Roth IRA for College

• More investment options. When you open an IRA, you can invest in a wide range of securities, including stocks, bonds, mutual funds, exchange-traded funds and CDs. You can choose your own investments and manage your own portfolio. By contrast, a 529 plan is much more limited in its investment options, and you have much less control over the portfolio.
• Greater flexibility. With most college savings accounts, you can only use the money for qualified education expenses. If you violate those rules, you could be subject to hefty penalties. With a Roth IRA, you have more flexibility. You can use the money however you wish; if you’re over the age of 59 ½, you can use the distributions for any purpose without paying taxes or penalties on the distributions.
• Not limited to one beneficiary. If you open a 529 plan, you have to select a beneficiary. The account can only be used for qualified education expenses for that person. With a Roth IRA, you can use the money for anyone, and you can change your mind about how to use the money at any time.

Cons of Using a Roth IRA for College

• Income tax on withdrawals. Money can be withdrawn tax and penalty-free once you reach the age of 59 ½. If you use it earlier than that for educational expenses, the penalty is waived, but you will have to pay income taxes on the withdrawals.
• Eligibility requirements. Unlike traditional IRAs and 529 plans, there are restrictions on who can contribute to a Roth IRA. You can only contribute to a Roth IRA if you make less than $144,000 (less than $204,000 if you’re married and file jointly).
• Loss of retirement savings. By using your Roth IRA to pay for your child’s education, you’re chipping away at your own retirement fund—and losing out on future earnings.
• Withdrawals are considered income. Distributions from a Roth IRA are counted as income on the FAFSA, potentially limiting the financial aid your child can receive.

What Is a 529 Plan and How Does it Work?

A 529 plan is a tax-advantaged account specifically designed to save for future education costs. There are two types:

• Prepaid tuition plan. With a prepaid plan, you can purchase units or credits for your child’s future use at today’s prices. However, the credits can only be used for their full value at select schools, and the credits can only be used for college—you can’t use them for primary or high school.
• Education savings plan. The education savings plan allows you to invest money for your child’s future. You can use the fund to cover tuition and room and board at a school of your child’s choosing, and you can even use up to $10,000 per year to pay for primary or secondary school.

Pros of Using a 529 Plan for College

• Contributions may be tax deductible. While contributions to a 529 plan cannot be deducted on your federal tax return, you may be eligible for state tax deductions or credits. For example, the following states offer deductions:
  • Arizona. In Arizona, you can deduct up to $2,000 per year, per beneficiary, from your state income tax return ($4,000 for married couples that file jointly).
  • Montana. If you’re a resident of Montana, you may be eligible for a deduction of up to $3,000 per taxpayer annually ($6,000 for those married filing jointly).
  • New York. When you file your New York state tax return, you can deduct up to $5,000 of your contributions to a New York Direct Plan account ($10,000 if you’re married filing jointly).
• Tax-free earnings. If you use your 529 plan withdrawals to pay for qualifying education expenses, the earnings are tax-free.
• Higher contribution limits. While a Roth IRA limits how much you can contribute, 529 plans don’t have the same restrictions. There’s no limit on how much you can contribute to a 529 plan per year, though lifetime maximums may apply.

Keep in mind that contributions to 529 plans are treated as gifts for tax purposes. As of 2023, the annual gift tax exclusion is $17,000.

Cons of Using a 529 Plan for College

• Fewer investment options. With a Roth IRA, you have a wide range of investment options, and you can pick your own investments. With a 529 plan, your options are more limited. You can usually only pick from a pre-selected list of portfolios.
• Penalties for other uses apply. If you use the money in a 529 plan for other expenses beyond the beneficiary’s education, you’ll have to pay taxes and a penalty.
• Limited to one beneficiary. The money in a 529 plan can only be used for one beneficiary’s expenses. However, you can switch or transfer beneficiaries if your child gets a full scholarship or isn’t attending college.

Should You Choose a Roth IRA or 529 Plan?

When it comes to Roth IRAs versus 529 plans, there’s no one-size-fits-all answer for everyone. Which is best for saving for college is dependent on a number of factors, including how much money you can afford to save each year, your child’s education goals, your state’s available tax deductions and your income.

If you decide that a 529 plan is the right option for you, consider the best 529 plans to start saving.