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. Read more on 529 plan rules here.
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.
For help selecting your plan, use NerdWallet’s 529 Plan Finder tool.
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.