Roth IRA vs 529 Plan: Which is Best for Your Child’s College Savings?

shutterstock_105914993 (1)

While it is commonly said that for most people a home purchase is the largest investment they will ever make, a parent’s investment in their child and the child’s future – including college tuition – oftentimes far exceeds the costs and financial complexity of a simple real estate purchase. Of all of the expenses parents face during a child’s upbringing, very few are more dreaded than the eventual price tag associated with attending college.

By taking a look at different investment options and financial planning strategies, parents can compare the different options at their disposal which can make saving for a child’s education a feasible task. In this situation, most parents consider either a 529 Plan or a Roth IRA as the ideal way to save. This article will focus on a few of the advantages of each so that you can make an informed decision as to the correct savings strategy for your family.

How Can a 529 Plan Help You?

A 529 plan is an investment option sponsored by either a state-level government or an educational institution. There are two types of 529 Plans, Prepaid Tuition Plans and College Savings Plans, with each having varying specifications to further help you choose the ideal savings plan for your child. Overall, 529 Plans have a number of benefits which separate them from Roth IRAs when it comes to saving for your student’s future, including:

  • Of the two different types of 529 plans, prepaid tuition plans have more restrictions but allow parents to lock-in tuition costs at a specific rate when opening the account. This is a great option when significant tuition increases are expected between opening your savings plan and your child going to college.
  • Many states offer state tax deductions on contributions to eligible state-sponsored 529 plans.
  • There are no income restrictions on contributing to a 529 plan, so this option is open to families whose annual earnings exceed the $176,000 maximum for Roth IRAs.
  • Annual contribution limits are often quite high, well into six-figures, whereas a Roth IRA currently has an annual cap of $5,500.
  • For children who earn scholarships to college, a 529 plan can be used for other educational expenditures with no penalty.
NerdWallet investigated 529 plans across the nation to find the best performing plans both offered by states and by brokerage firms: NerdWallet’s list of best 529 plans by state is available for those who live in these states.  For those without state tax deductions or if you don’t want to sign up for a state’s plan, NerdWallet’s favorite 529 college savings plan is the TD Ameritrade plan. This low cost plan has no minimum to start and great investment options from across a wide variety of well-respected fund families.

 

  • No minimums – There is no minimum initial contribution requirement to open an account, nor is there an annual minimum contribution in order to maintain an account.
  • If you use a payroll deduction plan or monthly automatic deductions from your bank account, there is no minimum initial or subsequent required contribution for any investment option.
  • Low expenses – Weighted average operating expense ratio of 0.26% is well below the industry average.
  • Read NerdWallet’s full review of TD Ameritrade for more details

 

When a Roth IRA Becomes Useful

A Roth IRA can be a smart place to stash that college cash for the following reasons:

  • In the event that your child does not go to college, your invested funds can be shifted towards your retirement, rather than needing to be used for another family member’s education or facing withdrawal fees as seen with a 529 plan.
  • Roth IRAs give you much more freedom and flexibility on how to invest your funds, whereas 529 plans often have limited options.

NerdWallet’s Top Picks for Roth IRA Accounts:

Best Overall Value IRA

  • Great research, analysis software, and best in industry customer service at reasonable prices ($9.99 per stock trade)
  • 2,500+ No Transaction Fee Mutual Funds
  • Free research reports about individual stocks
  • Free no-obligation consultation with a registered investment advisor (RIA)
  • Free analysis software with screeners and alerts
  • Free access to Level II quotes, allowing investors to gauge market depth and liquidity, not just last trade price
  • Top rated by SmartMoney, Investor’s Business Daily, Barron’s, and others
  • Mobile app for iPad, iPhone, and Android
  • 24/7 customer service
  • Check writing & Debit Card
  • Free automated phone trades
  • Over 100 physical locations
Best IRA for Inexpensive Stock Trading

  • Only $4.95/stock trade
  • No minimum deposit
  • Free research reports
  • Free realtime data
  • Free analysis software
  • Free automated phone trades
  • Mobile access
  • Check writing & debit card
  • Asset classes include stocks, bonds, options, forex, ETFs, and mutual funds
  • Read the full NerdWallet review of TradeKing
Best IRA for Beginners

  • No Fees, No Minimums
  • Purchase low cost index funds for as low as $500
  • Basic tools, trading platform, and investment research included
  • 1,300+ No Transaction Fee Mutual Funds
  • Barron’s says “Terrific research hub”
  • Free research reports
  • Free realtime data
  • Mobile access
  • 24/7 customer service
  • Check writing & debit card
  • Physical locations
  • Reasonable price of $9.99 per stock trade
  • Asset classes include stocks, bonds, futures, options, forex, ETFs, and mutual funds
Best IRA for Options Traders
  • Barron’s says: “Terrific tools for options traders”
  • User-friendly options trading platform with extensive tools
  • Two flexible commissions plans for option trading allow both frequent and infrequent traders to tailor the plan to their own needs
  • Free research reports
  • Free realtime data
  • Free analysis software
  • Mobile access
  • Check writing & debit card
  • Asset classes include stocks, bonds, options, ETFs, and mutual funds
  • Stock trades are only $4.75
Best IRA for No-Fee Mutual Funds

  • Offers the most No Foreign Transaction Fee Mutual Funds (4,500+)
  • Free streaming quotes
  • Free broker access
  • Free realtime data
  • Free analysis software
  • Advanced trading platforms
  • Mobile access
  • Free automated phone trades
  • Check writing
  • Stock trades are $8.95
  • Assets classes include stocks, mutual funds, bonds, futures, ETFs, and options
Best IRA for Index Funds

  • Excellent selection of very low cost index funds
  • Average expense ratio is 83% less than the industry average
  • Offers 120 Vanguard funds and 52 Vanguard ETFs
  • Not ideal for those who want to trade stocks ($20 per stock trade)

When it comes to saving for your child’s college education, thorough planning can mean the difference between financial freedom to attend the school of their choice, and struggling to cover rising tuition costs. For parents, both 529 plans and Roth IRAs each present a number of benefits and disadvantages which need to be thoroughly examined in order to choose the right investment strategy for your financial situation and child’s educational goals. Every family and student’s financial needs will be different, so it is important to carefully identify your individual savings goals before choosing any investment plans.

  • worked for me

    I agree with Jim Mc… One of the biggest considerations as to where you should be invested is what is considered an ASSET on the FAFSA. If you have $100K in your 529 you need to list it on your form as an investment dramatically impacting your ability to get needs based financial aid… 100K, even a million, in a Roth and you list NOTHING. If you want to pull out your 70K Roth basis for example you still can.

    My opinion & experience on the best strategy is pay OFF your house and fund your retirement accounts (401K Roth) like crazy until the day your oldest gets to college. Then, use the equivalent of what was your mortgage (let’s say 1500 a month) and scale back your 401K contributions (let’s say 500 less a month) and fund your college with cash. You will max out your FAFSA and needs based aid while still being in pretty good shape at retirement.

  • govtwasted

    But the entire point of putting money away in to a 529 or other vehicle is so they won’t NEED aid. The goal is for your kids to leave college w/o a millstone of debt around their neck, launching them into the world already in a hole. So if your plan is not to fully fund, then you might as well put your money in the sock drawer and give it to them when they reach 18.

    • Rina Sandler

      Additionally, there is a limit on Roth IRA contribution of $5,500 per year($6,500 if you are over 50 years old ). MIT tuition is around $43K per year, Columbia is $60K. Even if you contribute all of 18 years of child’s life you would save only for 1.5years-2 years depending on college cost. In my opinion, one can use a combination of Roth IRA and 529 to maximize the benefit.

  • Curious

    I keep reading about Roth IRAs for kids for college, but how about a traditional IRA as a savings vehicle?

    • Maxime Rieman

      Here’s a great article outlining the pros/cons:
      http://collegesavings.about.com/od/rothiras/ss/rothiras_2.htm

    • Liz

      When withdrawing from a tradition IRA before the age of 59 1/2 you will be charged a 10% penalty. With roth IRA’s you can withdraw your contributions only before the age of 59 1/2 without paying a penalty as long as you have had the account established for over 5 years.

      • Barbara

        actually, ”
        Unlike traditional IRAs, distributions from Roth IRAs prior to age 59 1/2 may escape the 10 percent penalty for early withdrawals. If you’re over age 59 1/2 there is no 10 percent penalty for traditional or most Roth IRA distributions (that have been in the account for five years)….”