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Save Like a Superhero: Roth IRAs and 529 Plans

April 11, 2017
Investing, IRA
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By Winnie Sun

Learn more about Winnie on NerdWallet’s Ask an Advisor

Many people hear the term investing and think it means buying individual stocks or mutual funds, but that’s a very limited way of making your money grow long term. While you may want to load up on actual stocks or funds at some point, it’s also imperative for your financial health that you diversify and keep money sheltered from taxes.

As a financial advisor, I work with clients every day on their investments, and here is one of the best tips I can share: First reduce your biggest cost, which is usually taxes. Only then should you focus on stocks or mutual funds.

Here are two of my favorite types of accounts, which I call “superhero” accounts because they can do so much. Not only do they offer tax advantages, but they also can serve multiple roles in your financial plan. And yes, you should definitely consider these before you file your 2016 taxes.

Roth IRAs

Roth IRAs can be used for retirement savings, college savings, your hybrid emergency fund or a combination of all three. To be eligible to make a full Roth IRA contribution for 2016, you must earn less than $117,000 if you’re single and less than $184,000 if you’re married. The limits increase for 2017.

If you want to save for retirement but don’t have enough in the bank for an emergency fund, you can consider utilizing your Roth IRA for both. An emergency stash should have at least three to six months’ worth of bills and expenses to protect you in case of job loss or other financial emergency. To utilize the Roth IRA as an emergency account, aim to contribute the annual maximum of $5,500, or $6,500 if you are 50 or older. If you don’t need to use the annual contribution that year for an emergency, it gets stored away for retirement.

Your financial advisor can help you link your Roth IRA to your bank account to automate your deposits into your IRA each month, if making numerous contributions is easier for you than one lump sum. The amount you’ve contributed to Roth IRAs can be accessed at any time without taxes or IRS penalties. This gives you flexibility today and in the future.

» MORE: Best Roth IRA accounts

Roth IRAs may also be ideal for college tuition savings. They’re not reported as assets on the Free Application for Federal Student Aid (FAFSA), so they won’t hurt you or your child’s eligibility for federal and state financial aid. Important to note: To avoid penalties, this type of account must be set up at least five years before the first withdrawal.

Since Roth IRA money used for retirement is already taxed before it enters the account, your contributions will grow tax-free until retirement, that is, after age 59½. The Roth IRA has a very flexible choice of investment options for retirement, including mutual funds, individual stocks and bonds, exchange-traded funds, and even CDs and money market funds. Speak with an advisor to help you with your options on investing.

If you’re looking for a smart, easy way to kick off your savings, Roth IRAs are an excellent contender. Since there are so many options available, it’s best to consult a financial advisor to get personalized advice about which specific investments are best for your situation.

529 college savings plans

As the name suggests, these types of accounts are primarily used for college savings. With 529 plans, it’s best to open an account early. You can open an account for yourself and transfer it into the name of the child once the child is born. However, students of any age can benefit from these accounts. The account holder controls the account and chooses a beneficiary, typically a child or other family member. Parents often open these accounts for their children, but grandparents, other relatives and friends can also open accounts and make contributions. The savings in 529 plans can be used at four-year and two-year colleges, trade schools and graduate schools. Unlike other plans, anyone can open a 529 plan, regardless of income level. The money in 529 plans has to be reported on the FAFSA and will affect eligibility for need-based aid.

Though 529 contributions are not tax-deductible, when the earnings are used for college expenses they are not subject to federal tax, and in some states, they may not be taxed by the state either. Ask your financial advisor and tax advisor to check the laws in your state to determine the true tax benefits of a 529 plan for you.

An added benefit of 529 plans is that they are favorable for estate planning: Money contributed to 529 plans, for example from parents or grandparents, is considered a gift and reduces the taxable income of the contributor.

Roth IRAs and 529 plans are smart ways to save and brighten your long-term future.

Winnie Sun is the founding partner of Sun Group Wealth Partners in Irvine, California.