College Savings: Roth or 529 Plan?

Roth IRAs were primarily intended as a tax-advantaged way to save for retirement, but for some parents (and students with earned income), a Roth IRA can double as a college savings tool. On the other hand, state-based 529 savings plans were designed specifically to help families set aside money for future education costs.

Roth IRAs and 529 plans are both funded with after-tax dollars, contributions accumulate tax deferred, and qualified distributions are tax-free. Still, there are a number of key distinctions to keep in mind.


Eligibility and Contribution Limits

In 2019, the maximum IRA contribution for someone under age 50 is $6,000 ($7,000 for those 50 and older). Roth IRA eligibility limits phase out for single filers with incomes between $122,000 and $137,000 ($193,000 to $203,000 for joint filers).

Anyone can contribute to a 529 plan; there are no restrictions based on income. And lifetime contribution limits are high, typically $300,000 and up (gift tax rules may apply). Each plan has its own rules and restrictions, which can change at any time.

Use of Funds

In order for a 529 plan distribution to be tax-free, the funds must be used for qualified higher-education expenses or K-12 tuition.* Otherwise, the earnings portion of the distribution is subject to income tax and a 10% federal tax penalty.

A qualified Roth distribution can be used for anything — retirement, college, travel, home remodeling, and so on. If college costs are less than expected, you can put those Roth dollars toward something else.

Roth Distributions: Qualified or Not

If you will be 59½ or older when your child is in college and you’ve met the five-year Roth holding requirement, your distribution will be qualified, and you can use your Roth dollars to pay for college (or anything else) with no tax implications or penalties.

If you’ll be younger than 59½ when your child is in college, you can still use Roth dollars, but your distribution will not be qualified. This means the earnings portion of your distribution will be subject to income tax. However, you could withdraw up to the amount of your contributions tax-free. The 10% early-withdrawal penalty that normally applies to distributions before age 59½ is waived if Roth dollars are used to pay for college.

Financial Aid Treatment

Retirement assets aren’t counted by federal or college financial aid formulas, so Roth IRA account balances will not affect your student’s financial aid. By contrast, parent-owned 529 plans do count as an asset under both federal and college aid formulas.

Investment Choices

With a Roth IRA, your investment choices are virtually unlimited. With a 529 plan, you are limited to the investment options offered by the plan; you can change the investment options for your existing contributions only twice per calendar year.

Investors should carefully consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. Specific information is available in each plan’s official statement and applicable prospectuses, which contain this and other information about the investment options, underlying investments, and investment company.

Keep in mind that 529 plan investments may not perform well enough to cover education costs as anticipated. Also consider whether your state offers its own 529 plan, which could provide advantages and benefits exclusively for its residents and taxpayers. These benefits may include financial aid, scholarship funds, and protection from creditors.

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